October 3, 2016    10 minute read

How History Influenced The Construction Of The EU

A Single Market Analysis    October 3, 2016    10 minute read

How History Influenced The Construction Of The EU

The financial crisis does not seem to have ended in Europe, and people wonder whether the European integration has gone too far. Critics blame misguided political motivations, and assert that the monetary union has failed. At the same time, supporters of the European integration argue the euro crisis is due to a lack of integration and weak institutions. The solutions would lie in a banking, fiscal and tax union, if not the creation of the United States of Europe. To assess whether or not Europe has failed one first needs to understand what it was built for.

“The euro was the result of a long-term development that started in the aftermath of World War II. After experiencing political oppression and war in the first half of the twentieth century, Europe undertook to build a new order for peace, freedom, and prosperity. Despite its predominantly economic content, the European Union is an eminently political construct. Even readers primarily interested in economics would hardly understand the euro if they ignored its political dimension.”

Tommaso Padoa-Schioppa

Germany recovered more rapidly than France at the end of World War II, and French policymakers could not take the chance that Germany would not seek revenge. Jean Monnet, acting French Foreign Minister at the time, helped by French businessman and high-ranking civil servant Robert Schuman, pushed for the creation of the European Coal and Steel Community (ECSC). This way “any war between France and Germany becomes not merely unthinkable, but materially impossible.”

The Coal And Steel Community

In 1951, the ECSC was extended to other countries: Belgium, Italy, Luxembourg and the Netherlands. The ECSC was then used as an institutional template to create the European Political Community which included a common army, budget institutions and significant legislative and executive powers.

This Community would have been the equivalent of a political federation. French Parliamentary members refused to ratify the treaty, which therefore never went into effect. According to Alesina and Spolaore:

“The formation of a European federation across heterogeneous populations, which share diverse social and economic structures, languages, cultures and identities, would come with several benefits but also with high costs. The tradeoff between such costs and benefits is central to the political feasibility and stability of institutional integration among those populations.”

Potential benefits included economies of scale and a shared budget for defence and security. A European Federation with its budget and own redistribution policies could offer protection against asymmetrical shocks, hurting one region. A federal integration comes with high costs when countries are speaking different languages and having different customs and perspectives merge into one federation.

Different populations do not share the same views on how the government should be organised and to what extent it may intervene in the economy to modify the initial market distribution of scarce resources.

The French And German Example

France and Germany, for example, do not share the same opinions on military budgets or strategies. Even during the Cold War, when Europe faced one of the greatest threats to its very existence, it did not manage to agree on Federation and relied heavily on NATO umbrella.

The role of Germany in the European integration is not to be neglected. If one looks back at the 1952 treaty that would have set up a European Federation, the most astonishing thing is not that France did not sign it. It is that the others did sign it. One reason may be that Germany and Italy, the two biggest countries ratifying it had just emerged from WW II and technically speaking Germany was still a militarily occupied country in 1952.

Therefore, the costs of constraints in Germany and Italy could probably be balanced by economic and political benefits. It is common to consider France proposed the Coal and Steel Community to limit German control of its industry in response to the US Marshall plan.

Germany’s Plan

If Germany did accept the Community it was to free its hands and be able to negotiate a shared management on coal and steel productions, scoring at the end of the day “the removal of ceilings on permissible levels of industrial production” (Eichengreen) such as “French access to German coal was “the most important element of the Monnet Plan for France’s reconstruction.” (Berger and Ritschl).

It seems clear: European supporters Jean Monnet and Robert Schumann saw European political integration as too hazardous at the beginning and that economic integration would be easier to accomplish.

European supporters probably had in mind that once economic integration was achieved, members of the community would have no choice but to integrate into a federation politically. In March 1957, the six members of the ECSC signed the Treaty of Rome establishing the Single Market.

Enter The Single Market

According to a report from the European Parliament, The Impact and Effectiveness of the Single Market (1996), the Single Market reinforced “competition, economic performance and benefits to customers. The growing competition among companies in both manufacturing and services has accelerated the pace of industrial restructuring, resulting in greater benefits regarding competitiveness. A wide range of products and service are now available to the public sector and industrial and domestic consumers, at lower prices, and particularly in newly liberalised service sectors such as transport, financial services, telecommunications and broadcasting. The Single Market has come along with faster and cheaper cross-frontier deliveries resulting from the absence of border controls on goods, greater mobility among member states for both workers and those not economically active. Calculations of the overall economic effects of these changes suggest that the Single Market has resulted in: between 300,000 and 900,000 more jobs than would have existed in the absence of the Single Market.”

Explaining Trade

The Heckscher-Ohlin theory explains why countries trade goods and services with each other, the emphasis being on the difference of resources between them. This model shows that the comparative advantage is influenced by the interaction between the two countries have (relative abundance of production factors) and production technology (which alters the relative intensity by which the different production factors are being utilised during the production cycle.

A country having a bigger offer in one resource than in another is relatively abundant in that resource, and tends to produce more products that use that resource. Countries are more efficient in producing goods for which they have a relatively rich resource.

According to the Heckscher-Ohlin theory, the trade makes it possible for each country to specialise. Each country exports the product it is most suited to produce in exchange for products it is less suited to produce. If one supposes country A is relatively abundant in territory and will specialise in producing food and country B is relatively abundant in labour so it will specialise in producing textiles, then trade may benefit both countries involved.

Standing Up To Competition

The Single Market has helped European companies grow and stand up the competition against their American competitors. It has supported economic growth by implementing a better allocation of capital and labour.

The idea can be illustrated with an example, having a look at whether specialisations of Germany, France, Spain and Italy match their comparative advantages (Artus). One can first characterise each country’s specialisation as follows:

  • Germany: capital and consumer goods;
  • France: agribusiness and tourism;
  • Italy: agribusiness, tourism, recently capital goods;
  • Spain: tourism, recently capital goods;

If one looks at the following graph regarding foreign trade, one sees that:

  • Germany is specialised in capital goods and consumer goods;
  • France is specialised in agribusiness and tourism;
  • Spain is specialised in tourism, and in the recent period in capital goods;
  • Italy is specialised in tourism, agribusiness and in the recent period in capital goods.

graph natixis 2

natixis graph 1

(Source: Natixis)

This means the specialisation is:

  • High-end in Germany;
  • Mid and low-end in Italy, Spain and even more so in France, which is consistent with the levels of estimated price elasticities of exports.

So, in short, using Germany, France, Spain and Italy, we see the Single Market has indeed pushed countries to specialise according to their comparative advantages.

natixis data

However, the Single Market has not fully achieved its goals, as it has not succeeded in reversing the downtrend in European productivity and has not succeeded in bridging the gap with the US.

The Bruegel Institute highlighted three main reasons:

  • “Barriers remain prevalent under several headings and therefore the Single Market is not complete
  • Key complementary policies to the abolition of restrictions were not put in place
  • Some national policies were not supportive of the benefits of the Single Market”.

The burning issue is considering the consequences of the inclusion in the single market of Eastern European economies. In theory, the addition of new countries to the free trading area should have been viewed as a win-win situation. As competition becomes fiercer, specialisation is more precise, and labour and capital travel freely within the area, thereby responding with effectiveness to any economic shock.

Anti-Single Market Sentiment

Eastern countries are supposed to catch up with their Western counterparts, and Western economies are expected to benefit from an increasing demand that cannot be satisfied by local producers. As the crisis has severely hurt Southern countries, policy makers tend to realise Western countries have lost in productivity compared to their Eastern competitors, and tougher regulation on worker mobility has been put in place. This situation has sparked an anti-single market sentiment across Europe.

Why has the single market not delivered on its promises? It would be too easy to only blame policy-markers for not implementing the required laws. Maybe, the real problem is the lack of a clear definition of what the single market is supposed to make possible and how to reach its given goals. The article 3 of the Lisbon Treaty states:

“The Union shall establish an internal market. It shall work for the sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy aiming at full employment and social progress.”

So, to put it differently, the single market is one important aspect of the European integration, but it is not the only one. Some clarity on the long-term goals of the European Commission would be more than welcome. Moreover, better indicators of “social progress” are needed to fully capture the success of the European Integration.

In short, European integration’s history is a complicated and highly political one. The different cultural backgrounds of the different countries making up the European Union make it hard for them to agree on what the integration should look like in the future.

There are two ways to see Europe: one is a free trade area like MERCOSUR, NAFTA, which is the English way; the other would be a more continental way: a political and economic association of states. As the UK is out, it is time to put the economic integration of new countries in the single market on hold and focus on political institutions as a way out of the crisis.

An area characterised by a single currency, a single market but no great executive and legislative powers is not last long. The time for political integration has come even if it means a two-tier Europe.

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