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The external implications of closer European integration.

* The author is a Senior Research Fellow at the National Institute of Economic and Social Research, London and co-ordinator of the ESRC research initiative 'The Evolution of Rules for a Single European Market'.

The pages which follow contain five short articles on the ways in which countries outside the European Community are affected by the rapid pace of closer integration generated by the ideas embodied in the White Paper on Completing the Internal Markei' in 1985 and set to continue well into the 1990s with Economic and Monetary Union (EMU) and widening to include EFTA and East European countries. These papers were commissioned for a conference on The External Impact of Closer External Integration, held at the National Institute on 13th September, 1990 and have been revised for publication in the light of the discussion.

The process of effects from integration is evolutionary as the articles explain. Countries threatened by what they see as adverse consequences try to get the offending facets of European integration changed by diplomatic pressure and other lobbying. Firms in those countries also try to alter their pattern of trade, investment and production to optimise their position, rationalising their operations within the Community to evade barriers, reduce costs and benefit as much as they can from the internal market.

Some countries such as EFTA and developing countries which were formerly colonies of the member states have special preferences with the EC. However, these articles deal with the countries round the Pacific Rim, which include the world's most important trading nation, the US, the major competitive threat, Japan, the world's fastest growing economies, among them the members of ASEAN, and the developed countries which suffered most from UK membership of the EC; Australia and New Zealand. The articles by Woolcock, Yannopoulos, Pelkmans and Mayes deal with these four sets of countries in turn but the discussion begins with a further article by Mayes which introduces the forces at work in economic integration in Europe and provides the context for the four regional assessments.

THE EXTERNAL IMPLICATIONS OF CLOSER EUROPEAN INTEGRATION(1)

The happy outcome which is looked for in closer economic integration in the world is that all countries gain. This is particularly clear for a general removal of trade barriers, such as those indicated for the whole range of products by Stoeckel et aL (1990) or for individual products, such as the ending of the Multi-fibre Arrangement explored by Trela and Whalley (1990).(2) Here those who have been protecting their industries gain because the losses to producers are more than offset by the gains to consumers, those who have been discriminated against in the past gain because they can increase their exports and those foreign countries which were previously benefiting from privileged access to the protected markets gain because their loss of market share is more than offset by an expansion in the market. (3)

It is this happy picture which is sometimes presented for the current process of European integration.(4) The member states will all gain because the increases in efficiency will at one and the same time reduce prices for consumers and increase the competitiveness of European producers both inside the Community and in wider export markets. This will generate further dynamic gains as the rate of economic growth will increase markedly, by up to 1 per cent a year if we are to believe Baldwin (1990). In the happy case this expansion of European demand is sufficient to offset the losses that foreign countries experience as a result of the improvement in European efficiency. In any case foreign firms can participate in many of the benefits of the Single European Market as they too do not have to incur all the costs of internal border controls and different technical requirements. Furthermore, if they would like to gain the benefits which accrue to producers in the European Community they can always do so by setting up their own facilities through direct investment.(5) However, general gain is by no means a foregone conclusion. The actual outcome depends upon the balance of favourable and unfavourable forces. Adverse outcomes for third countries are just as possible as beneficial ones.

In practice, of course, the primary aim of completing the European Internal Market and indeed 'Economic and Monetary Union' was not to improve the welfare of the world as a whole but to benefit the member states of the EC, indeed to benefit them relative to their competitors. As Jacques Delors put it in the foreword to the Cecchini Report, This large market without frontiers ... gives a unique opportunity to our industry to improve its competitivity' (Cecchini, 1988, p.xi). His very next sentence talks about the world as a whole but is ingeniously ambiguous. 'It will also increase growth and employment and contribute to a better balance in the world economy'. [emphasis added]. He says neither what better' means in this context nor for whom it is 'better'. My interpretation is that European growth and trade performance will improve relative to the other advanced countries.

The presentation of the impact on the rest of world is clearly a matter of diplomatic sensitivity. In order to comply with general GATT principles, preferential agreements between groups of countries need to appear to be a step towards free trade, so that any losses to particular countries are clearly outweighed by the general gain. It is not clear how far GATT principles apply to the Single Market proposals as they do not relate to tariffs and in only a relatively limited manner to the increased competences being negotiated in the current Uruguay Round on areas such as services and TRIMs (Trade Related Investment Measures). The international acceptability of the closer European integration would clearly be improved if, nevertheless, the various measures did in fact conform to something like the GATT principles.

It is equally clear that this was not the initial message received by the US and Japan about the nature of the Single Market Programme. There it was viewed as an attempt to increase relative protection and likened to earlier proposals which advocated a 'Fortress Europe' approach to improving the position of European industry. This message was emphasised by talk of reciproCity,(6) particularly concerning motor cars and in the first drafts of the Second Banking Directive in 1988. Here benefits were only to be extended to trading partners if the EC received similar treatment in the same industry in the partner's country. Thus, for example, it was proposed to admit two Japanese cars to Europe for every one European car sold in Japan.

The new Commission which took office in January 1989 changed the approach markedly as can be seen from the final form of the Banking Directive and the attempt to negotiate a Europe-wide VRA with the Japanese car manufacturers. In part this change of view will have been a response to the external pressure which was brought to bear.

In this paper therefore we try to deal with the external implications of closer European integration as it is currently evolving rather than as might have originally been intended or indeed, as it might be amended in the future if economic prospects become harsher. The degree to which the happy scenario of all benefiting could occur depends upon the relative extent of the competitiveness and growth effects and the actual ability of non-community producers to gain access to the market. Indeed, we do not have to look outside the EC to find potential losers. There are clear worries that the balance of effects may be unfavourable for peripheral' regions or countries even within the EC.(7)

The nature of the external implications Assessing the nature of the external implications of closer European integration is a multi-stage process. We could begin by listing the changes in legislation and the regulatory environment which form part of the Single Market programme. To this could be added hypotheses about the legislative changes which will emerge from the two intergovernmental conferences on Economic and Monetary Union and on Political Union. Indeed, we could speculate further about the changes which will take place in the 1990s in widening the Community to include Eastern European and EFTA countries. We can then go on to assess how the various market players, both within the EC and outside it, react and then calculate the resultant impact.

This is roughly how the analysis behind the Cecchini Report on The Costs of Non-Europe' proceeds although it tends to conflate the first tWo.(8) The first step used there was to assess the implications of the Single Market measures in terms of potential cost reductions. Using models of how the economies have responded in the past it then estimated the outcomes. However, this is an artificial exercise as it assumes both that all the Single Market measures will be implemented and that the market will respond fully to them.

In practice we need to make a more complex assessment (see figure 1). First of all we cannot assume that any specific regulatory change achieves its objective. For example, it may not be the binding constraint. Permitting labour movement into an area achieves little if there is a shortage of housing or if the price differential is such that people cannot afford to move. Second, the market may react so as to frustrate the intention-a potential cost reduction may not be passed on fully in an oligopolistic market, for example. Thirdly, it is one thing to legislate it is another to be able to enforce the legislation. The UK government has struggled for years to try to control local authority spending, with singular lack of success where the local authority did not share the same objectives. It is thus highly unlikely that where public purchasing is relatively small scale and highly decentralised that any effective scheme can be devised to ensure that competition is fully open to all Community suppliers. Lastly, it is by no means the case that third countries will sit idly by. They can themselves initiate legislation or behaviour which will offset the effects of changes in the SEM programme.

We therefore need to amend the simplistic views of impact by taking account of all three of these influences.(9) However, even this restriction in scope does not grasp the full picture as the actual regulatory changes are themselves the result of internal and external pressures (figure 2). The process of embodying the proposals in the 1985 White Paper in appropriate directives, regulations and other legislation is itself one of negotiation and compromise (although the Single European Act has increased the number of occasions on which qualified majority voting can be used). Not only do governments within the member states have to agree the proposals through the Council of Ministers but there are strong lobbies, both directly to the Commission through Brussels offices of major firms, organisations and professional groups, and through the European Parliament. This period of development also gives the opportunity for governments and lobbyists from other countries to influence the legislation. This has been clearly instrumental in achieving change in some areas such as the Second Banking Directive.

In some areas representatives from organisations in other countries are actually involved formally in the decision making. Part of the process of technical harmonisation involves standards setting through CEN and CENELEC to which the EFTA countries also belong. International rail standards in Europe involve the East European countries as well. The importance of being a party to the negotiations on technical harmonisation is emphasised by the US request for 'a seat at the table'.

To simplify understanding of these questions Box 1 sets out briefly the nature of changes involved in the programme for Completing the internal Market' by the end of 1992. Box 2 shows the process of agreement and decision-making necessary to get those changes embodied in legislation, rules and regulations in the member states.

Much of the influence on the evolution of the system particularly on technical details comes not from governments but from companies. Companies are not merely involved in the rule-making in European integration as participants in the bargaining but also as players in the game, reacting to the rules and their probable impact. These initial reactions and concern about other possible actions will themselves influence the decision-making process.

Influence by companies in third countries as opposed to influence by governments does not have to be external. It is possible to become a Community player by investing inside the EC. This can be by acquisition of an existing company, greenfield investment or indeed, by co-operation agreements and joint ventures.(10) A large proportion of that route of influence comes through the UK, aided by the ease of entry. There are many reasons for this-more firms can be purchased on the market, a long tradition of foreign ownership, use of English, and so on. However, operating from the UK brings with it the difficulties that UK companies themselves face, with a different legal structure and approach from many of their continental rivals.

The article by Woolcock on the US in this section focuses on policy reactions both by the government and by firms because they both have major market power. Trade with the US is important to the EC as the largest single external market. US support for the measures involved in European integration or at least its acquiescence in them is necessary for them to have the impact intended. The mature US multinationals, whose European subsidiaries like to be thought of as European companies are major players in the detailed lobbying and decision-making process in European integration. It is noticeable as Woolcock points out that the major objectors in the US are those who are not major players inside the Community or who are bothered that they may not be able to continue to play such a role.

The article by Yannopoulos on Japan on the other hand focuses strongly on response by Japanese companies, in the main because their maturity in the process of tackling European markets is far less advanced than that in the US. Companies rapidly building up a market share attract far more opposition from existing incumbents. This is revealed even more strongly in the case of ASEAN where concerns relate not so much to the Single Market per se but to Community commercial policy. Although efforts are made to separate these two issues by the authorities in Brussels the two are not unrelated. While integration measures are aimed at improving the efficiency of the use of resources within the Community by removing unnecessary internal barriers they are also aimed at improving the competitiveness of European industry with respect to the rest of the world.

My own article on Australia and New Zealand takes this emphasis on what is not involved in the current steps in European integration even further. in their case they do not have the strong growth in other areas to offset EC protection in their major export areas. Their concern is therefore far more with what the Single Market is not but could be rather than what it is. Without the major bargaining power from their importance in trade for the EC or a wide range of significant multinational companies they are recipients of EC policy rather than effective participants in the process of policy determination. Like the ASEAN countries, trade with the-EC both as importers and exporters is far more important to Australia and New Zealand than it is to the EC. Expansion of links with the East European countries may easily have further adverse effects on Australia and New Zealand such as those relating to Polish agricultural products and the major sale of East German butter to the Soviet Union which means that the Soviets will not be buying on the open market this year.

Closer European integration

There are three main forces of European integration at present which have important external implications; first, and most developed, the steps towards completing the internal market-the 1992 programme-second Economic and Monetary Union and lastly the widening of the Community both to existing EFTA members, Austria already having applied for membership, and to Eastern/Central Europe with East Germany having become a part of the Community on the unification of Germany in October. The tendency thus far has been to focus on the 1992 programme but with the speed of change firms and governments in third countries have to look to the wider issues of European integration in the 1990S.

The single market

The structure of the influence of the Single Market measures on third countries is outlined in table 1, following a similar framework to that of Yannopoulos (1990). The Single Market is an ambitious attempt to remove unnecessary regulatory divisions in the European Communities. As such it involves both 'positive' and negative' measures. Negative' measures in this sense involve stopping existing discrimination while the positive' measures involve setting up new common regulatory frameworks which apply across the whole Community. (Ending discrimination may also involve new measures so the positive/negative distinction should not be taken too literally.) Taking the negative' first, these negative measures are in effect a liberalising of the market, with the removal of barriers at the frontiers to the free flow of goods and services, the mutual recognition of others' qualifications, systems of accreditation and so on, the opening of public procurement to producers in other member states and a string of other measures set out in Cecchini (1988). Some of this liberalisation applies to all goods and services within the market irrespective of place of production, in that with no internal frontiers all can move freely.

Some opportunities not to extend these benefits of freedom of circulation of goods and services within the EC to third countries will however continue to exist. In the case of motor cars and other items which have to be registered before they can be used it is possible to control foreign market penetration without having any internal border controls in the Community.

But for goods such as clothing, which retail widely, any effective control would be difficult to envisage; thus to a large extent the benefits must be available to third country producers. Nevertheless, exporters still face the frontier barriers of getting into the Community at all. While the costs of the delays involved at the frontier may be relatively less than the costs of shipping long distances to the EC, this still means that relative prices move in favour of EC producers as they have no frontiers to cross.

Services are rather a different matter as most require local establishment which again offers an opportunity for control of third country producers and hence, discrimination against them even though third country banks, for example, can benefit from operating under 'home country' control in their place of principal registration inside the EC, that is still a second administration to cope with in addition to their own country's.

Public procurement continues as a discriminatory device against those in third countries although there is the opportunity to participate if reciprocal benefits are offered. The preference of public purchasers for domestic products despite price and quality disadvantages is the norm round the world so in many respects the EC is going rather further towards liberalisation than most countries. Hence, seeking 'reciprocity' is an understandable stance (even though it may deny EC purchasers the best 'value for money' if they choose not to open their purchases unilaterally).

Where local capacity does not exist it is commonplace to ask for offsets' when permitting foreign imports, that is, requirements that part of the product is produced locally or that other activities are brought into the local area. Many of the reasons for preferring local supply such as security and rapid response are practised widely in the private sector as well. It is merely that private firms are under no obligation to justify their purchasing decisions to the public at large. The appropriateness of their strategies will be reflected in their relative performance.

The application of mutual recognition is not so straight forward for third countries. First of all it does not apply to qualifications and to the movement of people, unless they happen to have a qualification in a member state. Secondly, it would be normal for a third country to seek type approval or certification in its domestic market first before going on to export. Companies in member states would be able to go on to export elsewhere in the EC provided they meet the minimum requirements with respect to health, safety and the environment but foreign companies need to obtain a second registration within the EC, thus slowing market entry and adding to its costs.

In addition to liberalising, many of the Single Market measures involve harmonising existing rules and regulations to a common form (the positive' measures referred to earlier). Although one of the main reasons why the 1992 programme has proved such a major step forward in the pace of European integration is that much detailed harmonisation no longer has to be agreed by Community institutions, harmonisation is still a major problem. First, in many cases an agreement is still required but responsibility for it has merely been passed on to standards institutions such as CEN and CENELEC. These organisations may very well be more adept at getting agreement and indeed may conclude better' agreements but the initial result is that a log jam of cases has built up. As a result it will still be a very long time before a Single Market is reached in technical requirements. Secondly, the way in which the harmonisation which is still required is taking place seems to have a penchant for combining the most restrictive aspects of each of the member states, rather than the lowest or a compromise. Third countries are concerned that quarantine and health standards are being used as a covert means of protection. This results in both costs and benefits for third countries. They are excluded from the discussions of the common standards-although, of course, if a third country company is the world leader and a major European producer to boot, as with IBM, it can still dominate the process. On the other hand the third country does not have to adhere to safety or environmental requirements in production nor to the measures in the social dimension of the Single Market programme. While this may benefit some LDCs this is of less help to developed countries which already have strong social obligations on employers.

In general a company will benefit if the common standards are closest to its own standards. This is least likely for companies outside the US and Japan as their standards can differ from those in all other countries, thus giving some Community producers an edge. However, the need to adjust can occur even where there is little or no production in the EC. New Zealand, for example, is currently trying to attain EC standards certification for radiata pine its main commercial timber, which is not normally grown in Europe.

Two aspects of the Single Market which can offer a benefit to third counties are worth mentioning. The first comes from competition policy. EC companies are restrained both in the EC market share and in practices such as vertical restraint agreements within the Community. The EC authorities whether Commission or national governments have no such jurisdiction outside the EC. Thus a third country company can benefit from a monopoly position in other parts of the world and from restrictive practices which boost its profitability. It can use this strong base to be a more aggressive competitor within the EC. However, the cross-subsidisation implied would only make sense if it were a temporary means of attaining a competitive position which would then be sustained without it. Of course the opposite may apply when local Trade Practices or Commerce Acts are actually harsher than those in the EC. In any case a foreign company has two sets of legislation to worry about: its own domestic and that in the EC which itself has both a Community and a member state component.

The second area of possible benefit comes in the form of state aids, which are heavily restricted in the Single Market to ensure equal treatment of companies from all members states. No such restrictions apply to third countries except those which might be caught under anti-dumping rules of the GATT. Again therefore the net effect depends on the relative circumstances applying in the particular third country. In the case of New Zealand the rapid run down of state aids could mean that the balance is actually unfavourable.

Adding these various factors together the net effect of the Internal Market on relative costs seems to be clearly negative for most third country companies, although some like insurers and brewers will have improved access and those whose business is transport and distribution can benefit from market growth. Insofar as reciprocal removal of restrictions cuts costs and removes distortions there will be further gains. The crucial question, however, is the extent to which the European market expands as it is this which provides the possibility of a clear net gain to third countries.

The sensitivity of the external impact of the Single Market to the relative size of the growth and relative cost effects is demonstrated by Stoeckel et al. (1990), who provided one of the few attempts to quantify the effects of the 1992 programme on the world as a whole, using a general equilibrium model (both income and price effects are allowed for). They explore three scenarios (labelled 'simple', adjusted', 'restricted' in table 2) where in the simple case the lowering of costs in the EC plus the increase in demand leads to an improvement in the trade balance. Under these circumstances there are losses for both North America and Japan but Australasia and ASEAN benefit(11).

If on the other hand the EC countries were to expand their economies enough to eliminate this improvement in the balance of trade, the 'adjusted' case, referred to in table 2, the picture is substantially changed. The North American loss is transformed into a small gain and the Japanese loss is largely eliminated but this is in part at the expense of Australasia and ASEAN. These are two polar cases of the way in which adjustment might take place. In practice if a trade surplus opens up in favour of the EC this might be expected to result in a rise in EC exchange rates, particularly if the dynamism of the Community attracts further investment from outside. Thus in practice the outcome would tend to involve a combination of a demand increase and a change in the terms of trade.

However, these first two simulations assume that the new external restrictions placed on third countries at the Community level after 1992 are equal to the average of the restrictions imposed by the individual member states at the outset of the process in 1986. If a more pessimistic 'restricted', view is taken and the agreed levels lie half way between the average and the most restrictive of the individual member states the picture is transformed. Everybody, with the exception of ASEAN, loses including the EC itself.

In many respects these results tell us rather more about the model than the economies involved as there is a very limited dynamic element in the model. As with all models calibrated on the past, policy and behavioral responses are not assumed to be affected by the shocks. In the case of the EC such changes are clearly hoped for as a deliberate consequence of the Single Market programme. Furthermore, in this form of simplified analysis only very general assumptions are made about the degree to which the Single Market proposals as set out in the White Paper are translated into legislation and about the direct impact of such legislation on costs. In general the assumptions made in the background papers to the Cecchini Report are applied. Even with the low level of impulse from 1992 simulated in Burridge and Mayes (1990) a third of the total impact comes from the feedback of the initial effect on the economy. If Stoeckel's simulations are to be believed it is clear that the US and Japan would have good reason to be unenthusiastic about the implications of 1992 under a range of plausible assumptions.

Economic and monetary union

Monetary union extends the scope of integration in a number of respects.(12) In the first place transactions costs are reduced as it is no longer necessary to change currencies between the member states. It also avoids the need for forward cover in those currencies. This is of disproportionate benefit to the member states themselves as they have a much larger proportion of their transactions with the other members.

Secondly, monetary union is expected to lead to considerable convergence among the member states in real terms, in policy and in structure, in itself contributing to what is described as economic union.(13) However, the emphasis in much of the discussions (see the various contributions to European Economy, No. 36, May 1988, for example) has been on convergence of inflation. As the rates of inflation in the member states fall towards that of the lowest (rather than the average) under the framework of the Delors Committee Report (1989) so real rates of interest can fall in the countries which currently experience more rapid inflation. it is argued, inter alia by Cecchini, that this fall in the cost of capital, aided by financial liberalisation under the Single Market, will tend to-stimulate investment and hence, productive potential and growth as the average age of the capital stock falls and its productivity rises (subject to diminishing returns of course). Foreign owned producers within the EC will benefit like the domestic companies but will still have a greater foreign exchange exposure than EC companies because of the greater need to deal in their own currencies.

However, a single currency in the EC is not without its problems as it removes part of the adjustment mechanism to external shocks. Regions within the EC may find that with nominal (but not of course real as inflation can still vary) exchange rate adjustment no longer available to them they have to deflate to adjust, with consequent high unemployment. if demand for a third country's products is concentrated in parts of the Community with adjustment problems, say, the UK, then the net impact will be less favourable than for countries focused on the fastest growing products and regions.

Again, therefore, as in the case of the Single Market the balance of positive and negative factors will probably be close to call. Simulations with GEM the National Institute's world model in A Strategy for the ECU suggest a net gain to third countries but convergence may prove more difficult. in any event, the position should be clearer after the inter-governmental conferences scheduled for December.

The debate has now been widened by the publication of 'One market, one money', no. 44 of European Economy which contains 'an evaluation by the staff of the Commission of the potential economic impact of forming an economic and monetary union'. This identifies 16 mechanisms by which EMU will have an impact. The chapter on the 'External dimensions' is, however, largely concerned with the role of EMU in the world monetary system. As a result of unity the EC would have a much larger influence on the world system, the ECU would become a major competitor to the US dollar as a world currency, becoming a vehicle for trade and cutting the transactions costs and exchange variability of those for whom it is the normal operating currency. There would also be gains from international seignorage and the reduced need for foreign exchange reserves in the EC.

Such changes might be of benefit to European banks as the prime transactors in ECU. The benefit to companies from a reduction in transaction costs with third countries is estimated to amount to only .03-0-05 per cent of EC GDP (although of course that is a large sum in absolute terms). internally in the Community the transaction cost gain from a single currency is much larger at around 1/2 per cent of G DP. This, however, is small beer beside the most striking calculations, which, in contrast to the Cecchini report, include estimates of a dynamic gain, based on the initial, static, impact, suggested to lie between 3.6 per cent and 16.3 per cent of GDP with a central value of 9.8 per cent, spread over 10 years (that is, 0.4 per cent to 10 per cent a year with a mean of 0.7 per cent(14) However, this is only part of the possible dynamic gain as the reduction in risk may itself lead to an increase in the rate of growth of between 5 and 10 per cent over the 10 year period. Taken together this would imply a growth rate effect of 1 .2 per cent a year.

If anything like these results turns out to be true the growth rate effect, increasing EC demand for third country goods and services, is likely to dominate any short-run adverse trade diversion. However, that adverse static effect comes first and the growth effect second. It is therefore worth asking whether there are dynamic losses for third countries under exactly the same logic. Their sales are hit, they invest in the EC instead of at home. Therefore for the gains from the dynamic growth in the Community to be a net benefit to the third country, they must offset the dynamic consequences of any initial adverse static effects. The final phraseology however is very guarded:

'it seems justifiable ... to consider a significant growth

bonus from EMU, while unproven, to lie well within the

bounds of plausibility'. (p. 84)

We can therefore anticipate that the calculation of the dynamic effects will attract considerable debate in the future.

The expansion of the Community

Although the response to the Austrian application for membership in 1989 made it clear that the Single Market programme was to be complete before any expansion of the EC was to be dealt with this has been swiftly overtaken by events in Eastern Europe and the Community was expanded by the addition of East Germany as part of a united Germany in October. Further expansion to include EFTA members and other Eastern European countries seems likely although accession periods may be long drawn out.

Insofar as this opens up new markets clearly this will be of benefit to third countries. But if it closes agricultural markets this will add to the problems of countries like Australia and New Zealand rather than reduce them. Furthermore, the East European countries are not just consumers but potential new producers, much closer to West European markets and in the transition likely to have lower unit costs than their Western counterparts and probably to concentrate on the less highly processed products. This adds to the competitive threat to Australia and New Zealand not just in Europe but in wider export markets as others try to follow the same drive to efficiency.

Stoeckel et al. (1990) have also simulated the impact of an expansion of the EC to include the East European countries, excluding the Soviet Union but including East Germany. The pattern of impact suggested (table 4) is very similar to that for the Single Market. The existing EC is a gainer, North America and Japan are losers, while such little impact as there is on Australasia and ASEAN is positive.

Concluding remarks

European integration is not occurring in a vacuum. As the four articles in this Review show, the reaction of Europe's major trading partners, particularly the US have influenced the path of the 1992 programme. It is not clear how much the spectre of Fortress Europe' was ever a reality rather than a negotiating position. Nevertheless, there have been significant reductions in the extent to which the benefits conferred by the Single Market would be exclusive to the member states, particularly through the rapid redefinition of the term reciprocity' in 1989 (as set out in CEPS, 1989).

The path of integration is also strongly affected by the actions and reactions of foreign companies. Foreign owned multinationals with a strong presence in Europe are full participants in the determination of the detailed characteristics of the internal market, not just in technical harmonisation but more widely with particularly some of the US multinationals being the best organised and informed lobbyists in the system. Because of the ability of such multinationals to alter the effects of the 1992 programme by major direct investment, whether offensive', defensive' or 'rationalising' as explained by Yannopoulos and illustrated for the case of Japan, simple calculations of the impact of the process of European integration are likely to be erroneous.

Such estimates as there are suggest that the nature of the overall impact will be affected by two important features. First, in a purely static context, it will depend upon the policy response to the improvements in the trading balance for Europe which are forecast, In particular, it depends upon how much integration leads to an increase in the rate of economic growth. it is this dynamic response, which has on the whole been poorly modelled, that is the second major contributory factor to whether, on balance, European integration will have a favourable external effect. insofar as it is weak, it appears from an analysis of the individual measures in the 1992 programme that even though many advantages may be open to companies from outside the EC, the net static effect could well be adverse for the major trading partners such as the US and Japan. ASEAN countries on the other hand seem set to benefit in any event while the impact on Australasia seems likely to be relatively small.

To some extent the assessment of the impact of integration is conflated with the evolution of the EC's trade policy in general. However, the advent of the Single Market does necessitate some changes in external trade barriers on sensitive products such as textiles and clothing and motor cars all of which, will have a positive effect on some external suppliers. It is also clear that the particular scope of the changes does not answer the major trade policy complaints of some third countries heavily involved in agriculture as represented by the Cairns Group. Here the impact of integration and the progress of the Uruguay Round are clearly intertwined. If as widely forecast the results of the Uruguay Round are rather limited, continuing pressure for the extraction of gains by the formation of trade groupings round the Pacific Rim can be expected. Such groupings would hope not just to emulate the EC by reaping efficiency gains from removal of barriers between the members but to reap gains from increased bargaining strength with the Community.

The process of further integration with Economic and Monetary Union and closer links with EFTA and especially East European countries will modify the position in two important respects. On the one hand it will result in a redistribution within the Community as part of the process of nominal and real convergence entailed by EMU. But on the other there will be a major revision of investment and trading patterns with the East. Insofar as initial measures involve more favourable treatment of agricultural products in the form of exports or imports this will exacerbate rather than help those already discriminated against by the CAP. However, the nature of the internal redistribution will itself cause the process of integration to change as those countries and companies which find themselves adversely affected are not likely to sit idly by. As in the case of the Single Market the proposals will evolve as the participants perceive their potential impact. Internal and external pressure will affect the final agreement and alterations in behaviour by companies and third country governments will affect the impact of the measures stemming from these agreements.

The evolution of the path forward is more complex than some of those describing an inexorable and irreversible process would like to think. The external impact of European integration plays an important role in that evolution.

NOTES

(1) I am grateful to Albert Meyer for research assistance and to Alan Bollard, Andrew Britton, Arthur Knight, Hans Liesner, Geoff Mason, Nick Oulton and Bob Webb for comments and advice.

(2) The general principles were set out much earlier in 1776 by Adam Smith in The Wealth of Nations.

(3) Calculations of loss and benefit are usually carried out in welfare terms, thus it is not the changes in trade shares as such which matter but the resource gains which stem from them. Thus, trade creation, the gain among members from substituting trade for domestic production, and trade diversion, the gain for members from switching trade from non-members (and concomitant loss for the non-members), are readily overshadowed by an increase in the rate of growth of the market. First, because the whole of that increase is a welfare gain and second, because the gain is dynamic not static. It is not a constant once and for all shift but increases every year.

(4) We can construct an elementary calculation on the basis of the Commission's macroeconomic simulations for the Cecchini Report (Catinat et al, 1988). After six years EC imports from third countries rise by 7.2 percent while exports to them rise by 10.5 per cent if the Internal Market is completed (table A.3.1). However, since the EC starts from a position of deficit this represents a net improvement in the trade balance of 31 billion ECU in 1985 prices or 1 per cent of GDP. However, as imports from outside the EC were 406 billion ECU in 1985 prices it requires only a small annual increase in EC demand to reverse the sign of the trade balance effect.

(5) This source of gain' is much more debatable from the point of view of the investing country. It is a switch of resources away from the investing country to the recipient country. Thus while the rate of return to the investing firm may be maintained a different view may be taken of the net impact on employment. It is this inflow of resources to the EC which is one factor contributing to the expected increase in the growth rate.

(6) This issue is dealt with more comprehensively in CEPS (1989), the report of a working party on l 992: the Environment for European Industry', chaired by Edmund Dell, for which the author was the rapporteur.

(7) See for example the Opinion of the European Parliament on the Commission's proposals for Economic and Monetary Union (European Parliament Working Document PE1 39.447/rev).

(8) The calculated cost reductions are combinations of the reductions theoretically available and those which will actually be realised.

(9) Yannopoulos (1990) argues further that reduction in non-tariff barriers has a weaker effect than their tariff equivalent. What is certainly clear is that it is not possible to apply the same methods that would be required for a tariff reduction of the same size to the cost reductions suggested by Cecchini.

(10) The ability to participate through direct investment has its limitations as there is an attempt to discourage 'screw driver' assembly operations where the European share of the value added of the final product is rather limited. (The limitation is not specific although there was pressure from some member states to make it 60 per cent.) There is only a formal limitation when the firm concerned is also subject to anti-dumping measures.

(11) The result is in the 'simple' case pose a problem when we look at the implications for the rest of the world. The total for the countries included in the table rather misleadingly labelled World' by Stoeckel et al, implies a net improvement in the balance of trade $156 billion. This presumably is netted out in the rest of the world, that is, LDCS, non-EC Europe and the Soviet Union. This seems rather unlikely. (I am grateful to Nick Oulton for this point.) The other two simulations have plausible implications for the rest of the world.

(12) This is set out in more detail in chapter 7 of A Strategy for the ECU, published by Kogan Page in May 1990.

(13) 'Economic Union' actually takes up more than half of the Commission's latest proposals on EMU (EC, 1990) yet its content is rather diffuse comprising the single market and closer co-operation and convergence implied by the policies accompanying monetary union. It is very different from the sort of close economic union many would expect from the term, such as that between England and Wales.

(14) These results are based on the models of Baldwin (1989,1990). Out of purely selfish interest I looked at the growth rate effects calculated in chapter 7 of my doctoral thesis (Mayes, 1971) albeit with a simple and somewhat flawed export-led growth model). Although in absolute terms they were rather smaller at .3-0.5 per cent in relative terms they were very similar with a medium run growth bonus of 70 per cent of the static effects compared with the 30-130 per cent considered here. This does not of course confirm or deny the validity of the results based on Baldwin's work.

REFERENCES

Baldwin, R. (1989), The growth effects of 1992', Economic Policy, October, pp. 248-81.

Baldwin, R. (1990), 'On the microeconomics of the European monetary union', in European Economy, The Economics of EMU', special issue.

Burridge M. et al. (1990) 'Oxford Economics Forecasting's System of Models', Economic Modelling (forthcoming).

Burridge, M. and Mayes, D. (1990) Industrial change for 1992' ch. 10 in Structural Change and the UK Economy, C. Driver and P. Dunne, eds. Cambridge University Press.

Catinat, M., Donnie, E. and Italianer, A. (1988) Macroeconomic consequences of the completion of the internal market: the modelling evidence', chapter 10 in Studies on the Economics of Integration, vol. 2. Research on the Cost of Non-Europe, EC Commission; Brussels/Luxembourg.

Cecchini, P. (1988) 1992: The European Challenge, Aldershot; Wildwood House.

CEPS (1989) 1992: The Environment for European Industry, Report of a Working Party, Brussels.

Delors, J (1989) Report on Economic and Monetary Union in the European Community, EC.

Ernst & Young, NIESR and AUM E (1990) A Strategy for the ECU, Kogan Page.

European Commission (1990) 'Economic and Monetary Union', Sec (90) 1659 final, Brussels (October)

Mayes, D.G. (1971), The effect of alternative trade groupings on the UK', PhD dissertation, University of Bristol.

Stoeckel, A, Pearce, D and Banks, G. (1990) Western Trade Blocs, Centre for International Economics, Canberra.

Trela, I and Whalley, J. (1990) 'Global effects of developed country trade restrictions on textiles and apparel', Economic Journal, December.

UNCTAD (1989) Trade and Development Report 1989, Washington: UN.

Yannopoulos, G.N. (1990) The External Implications of the Completion of the Internal Market of the Community, Report of a Working Party, CEPS, Brussels.
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Author:Mayes, David G.
Publication:National Institute Economic Review
Date:Nov 1, 1990
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