Economic Integration and the European Union

1. Economic Integration and the European Union

3. Introduction to Economic Integration • Forms of integration • Gainsfromintegration • EU structures • Institutions • Decisionmaking

4. Regional economic associations vs. global efforts (WTO) Trade liberalization vs. economic integration economic integration goes further and is more discriminatory Forms of Economic Cooperation between Nations

5. Forms of Economic Association • Free trade area (FTA) • Free trade between the members • Customs union (CU) • FTA + common external tariffs on trade with non-members • Common market (CM) • CU + free mobility of factors of production • Economic union (EU) • CM + common economic policy

6. Gains from Integration • Stop wars! • Better use of existing resources • specialization (comparative advantage) • lower prices (intensified competition) • increasing returns to scale • Greater negotiation power • Better terms of trade

7. Let’s consider the static and dynamic effects of economic integration • Trade effect • trade creation and trade diversion • Pro-competitive effects • Economies of scale effects • Growth effects

8. Trade Effects of a Customs Union between Two Countries a) Country A Two small price-taking countries, A and B, facing increasing production costs SA DA b) Country B SB pt pu pw wt j a b c pB h f g k m d n w DB Q1 Q2 Q3 Q4 Q5 Q6 Q7 Trade creation a + c Trade diversion d Trade creation g One homogeneous product, no close substitutes.

9. Pro-Competitive Effects of a CU • If the size of a country’s market is limited and competition imperfect, participation in a CU will increase competition welfare benefits An Example: Let’s assume a monopoly market in country A, with demand curve DA and supply SA. Then DA= AR and SA= MC profit maximizing quantity = QA and price =pA,which is much higher than pU.

10. Pro-Competitive Effects of a CU Production Welfare changes Producers Consumers Monopoly - (c + d) Perfect competition - (c + d) c + d + g + z Pro-competition effects g + z pA SA = MC c d g z pU SU h DA= AR MR QA QU

11. Economies of Scale Effects in a CU • So far we have assumed increasing production costs in the countries forming the CU and constant production costs in the world market • In small countries with protected national markets it is possible that demand is not sufficiently large to allow production plants of the most efficient size • However, access to the enlarged market of a CU may provide the conditions for optimum size production and opportunity for cost reductions from exploiting economies of scale (in the real world, much trade takes place because of economies of scale rather than comparative advantage)

12. An Example • Assume existence of economies of scale in production of a commodity x produced in Country A • The domestic demand is too small to allow the producer to reach an efficient scale • Assume that due to restrictions in trade, exports would not be large enough either • When Country A joins a CU, restrictions are lifted and now there is enough demand • For sake of convenience we assume that the CU market allows volume of production that exactly matches A’s minimum average cost

13. Economies of Scale Effects continued Before customs union, A protects domestic production by a tariff. pA SA= AC pU DA DA+U Q3 Q4 Q5 Country A

14. Factor Mobility in Common Markets • So far we have assumed that factors of production are immobile between countries (in CU international trade takes place in goods and services only) • CM’s entitle the free mobility of capital and labor between member countries

15. Effects of Factor Mobility in CMcontinued • The advance of integration from CU to CM intensifies the tendency towards a single price for each commodity (service) and a single price for each factor of production • Common markets improve the allocation of factors across country boundaries as well as efficiency and welfare • Growth

16. Institutions of EU • Council of the EU (NB! Not the samething as EuropeanCouncil!) • Main legistalitivebodycomprising of ministers • Commission • Proposes new legislation, overseesexecution • Parliament • Approvescommission • Works togetherwithcouncil in legislativeissues • Court of Justice • Overseesthat national legislation is alignedwith EU law

17. Democracy in EU • Members of Parliament (736) electeddirectlybycitizen • The number of MEPs per country is proportional to populationsize (notlinearly, though!) • Mostlegislationhas to beapprovedby the parliament as well as the council (”twochambers”) • Members of the Councilareministersfrom the membercountries • Councilmembersrepresenttheir home countries; number of votesdepends on population • Depending on issue, eitherunanimity of qualifiedmajority is required • Votingruleswillchange in 2014 (Lissabon Treaty) • Commissionersarechosenfrommembercountries (and approvedby the parliament) • Commissionersarenotsupposed to advocate national interests

18. Democracy in EU: Councilvotingrules • The currentCouncilvotingrules: In order for a proposal to bepassed • 50% (if proposal was made by the Commission) or 67% (all other cases) of the members states, • 74% of the voting weights, which are based on the country’s size (Germany and France have 29, Finland only 7), and • 62% of the EU population • New votingrules in 2014: In order for a proposal to bepassed • Majority of countries: 55% if acting on a proposal from the Commission or else 72%, and • Majority of population: 65%. • Also, there have to be at least 4 countries voting against the proposal (and therefore the 3 biggest countries do not have an automatic veto right)

19. EU Policies and Legislation • EU legislation supercedes national legislation • EU wide legislation needed in order for the single market to function • E.g. differences in environmental and social policy would distort competitive advantage, social dumping • EU policies only in sectors that affect cross borders

20. EU Policies • Social policy • Regional policy • Agricultural policy • Environmental policy • Competition policy • Industrial policy • Transportation policy • Trade policy (vis à vis rest of the world)