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The Economics of European Integration*

Chapter 1 ‘Economic Integration in Europe’

Chapter 2 ‘The Traditional Theories of Customs Unions and Single

Market’

Chapter 3 ‘New Trade Theories and the Integration of CommodityMarkets’

Chapter 4 ‘Common Market Theory’

Chapter 6 ‘Micro Economic Policies’

Sections marked with blue are cursory reading.

*Updated and adapted manuscript from J. D. Hansen and J.U-M. Nielsen, An Economic

Analysis of the EU , McGrawHill, 1997.



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CHAPTER

ONE

ECONOMIC INTEGRATION IN EUROPE

1-1 INTRODUCTION

Economic relationships in Europe are changing. Trade, capital flows, migration and technology

increasingly link the economies of the countries of Europe. Basically, this trend is due to the

general globalization process on world scale which has taken place since mid of 20th century for

all market economies but in Europe the process has become much deeper due to the regional

integration in the European Union (EU). The EU includes most of the European countries as

members, namely: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Italy,

Ireland, Luxembourg, the Netherlands, Portugal, Spain, Sweden, the United Kingdom, Estonia,

Latvia, Lithuania, Poland, the Czech Republic, the Slovak Republic Hungary, Slovenia, Maltaand Cyprus. These 27 countries have developed a formal system of close co-operation aimed at

creating a cohesive economy encompassing the whole of the EU, and within which there is free

mobility not merely of goods but also factors of production. In other words it is hoped that in

many respects the 27 diverse economies can function as a single economic unit. This process of

dissolving the boundaries of the segmented economies illustrates the concept economic

integration.

The purpose of this book is to discuss economic integration in the EU within the framework of

economic theory. Though economic relationships are examined at a fairly abstract level, the

book has its roots in the economy of the EU as it exists today and as it may develop in the future.

The first chapter provides a brief survey of the history of the EU, the political decision making

process in the EU, its administrative apparatus or legal system. All the remaining chapters focus

the analytical economic aspects of the EU.



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Although this book thus concentrates on economic aspects, it should be kept in mind that the

overall goal of establishing the EU is to ensure a peaceful Europe without devastating wars

based on democracy, human rights and common values in general. This overall political motive

is the key for the understanding of the development of the EU from the very beginning in the in

1950’s to the last the last enlargements of the EU with countries from Central and Eastern

Europe in this century. To integrate the economies economically is in this perspective only a

mean or a strategy for securing a more peaceful Europe. Market economies bound together by

trade and movements of people and capital are less likely to keep alive past enmities.

International trade theory shows the potential for economic benefits of open economies, and

these benefits are more readily available as improvements in transport make the movement of goods cheaper and thereby reduce the friction of distance.

1-2 THE LEGAL BASIS OF THE EU

The legal basis for the European Union is the Treaty on the European Union (TEU) and the

Treaty on the Functioning of the European Union (TFEU). The two treaties together make up

the so-called Lisbon Treaty adopted in Lisbon by the Prime Ministers and Head of States of the

EU Member States in 2007 and put into force in 2009. The Lisbon Treaty consists of provisions

found in previous treaties as well as new provisions. The Lisbon Treaty is a result of an

evolutionary process where previous treaties have been transformed to new versions perceived

to be a more efficient legal framework to meet the challenges of the EU.

The founding treaties of the EU are the Treaty of Paris, signed in 1951, and the Treaty of Rome

and the European Atomic Energy Community Treaty, which was both signed in 1957. The

Treaty of Paris established the European Coal and Steel Community (ECSC) that regulates coal

and steel production and markets. The Treaty of Rome established the European Economic

Community (EEC), which covers the more general matters of the Customs Union, the Common

Market, the Common Policies for Agriculture and Industry and the Rules of Competition. The

European Atomic Energy Community (EURATOM) covers co-operation on the peaceful use of

atomic energy.



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The amendments to the provisions of the original treaties have both expanded and deepened EU

integration. The Treaty of Rome was amended both in 1986 by the Single European Act , which

laid down the guidelines for the establishment of the Single Market, and in 1993 by the

Maastricht Treaty which provides the legal basis for the monetary union. The more recent

treaties are the Nice Treaty, the Amsterdam Treaty and as mentioned above the Lisbon Treaty.

These latest three treaties deepened the cooperation between the Member States by introducing

foreign policy, defense police and policies for home and security affairs in the area of

cooperation and common policy making. Moreover, the recent treaties changed the rules for

decision making for the EU institutions in order to increase the capability to make decisions. The

need for such changes has been more urgent when a large number of countries with differentviews become members of the Union.

Table 1-2 summarizes the development of the legal framework of the EU.

The preamble to the TEU proclaims the establishment of the European Union and lists a set of

basic values and aims which all Member States share. To quote the most important aims and

statements, the Head of States who signed the treaty has:

“resolved to mark a new stage in the process of European integration undertaken with the

establishment of the European Communities”

“confirming their attachment to the principles of liberty, democracy, and respect for human

rights and fundamental freedoms and rule of law”

“recalling the historic importance of ending the division of the European continent and the need

to create a firm bases for construction of the future Europe”

showing their determination and the determination:

"to promote economic and social progress which is balanced and sustainable ... , to assert its

identity on the international scene, in particular through the implementation of a common

foreign and security policy ... and to strengthen the protection of the rights and interests of the

nationals of its Member States through the introduction of a citizenship of the Union.



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The overall goal for the European Union goes thus far beyond economic cooperation. Basically

the aim the Union is first and foremost to promote peace and ensure the basic values on

democracy, human rights etc. The benefits of economic cooperation should be seen as a lever for

these ultimate goals.

The EU has supra-national elements in that there are institutions which have the power to make

commitments which are binding on member states. The most central of these institutions are the

European Commission, the European Council of Ministers, the European Court of Justice, the

European Parliament and the European Central Bank (ECB). The Commission has the "right of initiative", that is it can make proposals for the implementation of EU policy and make plans for

the further development of the EU. Decisions about the proposals and plans are taken in the

Council of Ministers, which consists of ministers from all the member states. To some extent the

Council of Ministers can make decisions by majority voting. The Court of Justice is also a

supra-national body in that it can pass judgment not only for individuals and firms but also

member states. The Parliament has a right to be heard, and certain matters, such as the

appointment of Commissioners and the annual EU budget, require its approval. The European

Central Bank conducts the monetary policy for the group of EU-countries which participates in

the EMU.

1-3 DIMENSIONS OF EUROPEAN INTEGRATION

1-3-1 The widening and the deepening of the EU cooperation

The development of the European Union has been a dynamic process where the political and

economic framework has changed over time.



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Two dimensions of the integration process may be distinguished. The number of member

countries has increased from the six founding members in the ninety fifties, Germany, France,

Italy, Belgium, the Netherlands and Luxembourg, to now the above mentioned 27 countries. In

future more countries are expected to join the EU as several countries have applied for

membership, and it is highly likely that Croatia will soon join the EU as the 28´s Member State.

This process of an increasing number of member countries is termed widening as the

geographical domain of the EU is extended. The other dimension of integration is related to the

transfer of competences or policy areas from the national level to decision making at the EU

level. This process is termed deepening as the functional scope of the EU cooperation increases.

The deepening process will be discussed more explicitly in the following.

1-3-2 A Conceptual Framework for Various Depths of Economic Integration

Economic integration may be of varying depth, as is illustrated in Table 1-1.

A free trade area consists of a group of countries among which trade takes place freely, that is

without being restricted by the barriers of tariffs (customs duties) or quotas (quantitative

restrictions) on trade. Such barriers are often called visible trade restrictions, and this is the term

used in Table 1-1. A free trade area is a relatively weak form of economic integration, for

participating countries retain the right to decide individually what tariffs and quotas are imposed

on countries outside the free trade area. Well known examples of free trade areas are the

European Free Trade Association (EFTA), the North American Free Trade Agreement

(NAFTA) and the Asian Free Trade Area (AFTA).

In a customs union there is not merely free trade between member countries, but there is a

common external tariff, that is all member countries impose the same tariffs on countries outside

the customs union.



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Table 1-1 Main Types of Economic Integration

No internal

visible trade

restrictions

Common

external trade

restrictions

No internal

invisible

trade re-

strictions

Free mobili-

ty of factors

of product-

ion and

financial

assets

Common

currency

Common

economic po-

licy

Free trade area x

Customs union x X

Single market for

commodities

x x x

Common market x X x X

Monetary union x X x X x

Economic union x X x X x X

In a single market for commodities (often shortened to single market and also known as an

internal commodity market) all restrictions on trade within the market have been abolished. Thisis true of both visible and invisible barriers. The latter include such obstacles to trade as product

standards that differ from country to country and the tendency of public authorities prefer to buy

from domestic suppliers. A single market, like a customs union, has a common external tariff.

A common market presupposes a single market for commodities, and in addition has free

mobility of factors of production and of financial assets. Thus, any citizen of a common market

country can obtain employment, establish a business and make passive investments in bank

accounts or securities in any common market country without approval from any authority,

unless such approval is also required of citizens of the country concerned.

A monetary union reflects an even higher degree of integration, for it presupposes a common

market and in addition either irrevocably fixed exchange rates or a common currency for all

member countries so that economic transactions within the union are not affected by exchange

rate uncertainty. However, the weaker form of monetary union, fixed exchange rates, implies

some exchange rate costs.



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The term quasi monetary union is sometimes applied where exchange rates in principle are

fixed, but may be adjusted.

An economic union is a monetary union in which the economic policy of member countries is

extensively coordinated. Since monetary union implies a unified monetary policy, the further

integration brought about by an economic union mainly concerns fiscal policy. In principle, an

economic union has uniform or very similar tax rates and procedures, a high degree of

uniformity in transfer payments (such as social benefits), co-ordination of government

expenditures as stabilization policies are now a matter of common concern, and also co-

ordination of sector policies such as taxation and subsidy of agriculture and manufacturing. Thecompleteness of economic unions may of course vary, as we see if we compare the integration

of the countries of U.K. with the looser integration of the provinces of Canada or the states of

the U.S.A.

Conceptually, we distinguish between negative and positive integration. Negative integration

consists of the removal of rules discriminating against partner countries in the union. Positive

integration consists of common efforts to reach a specific objective. The creation of a free trade

area, a customs union, a single market or a common market are all cases of negative integration,

for their essence is the removal of restrictions on the mobility of goods or factors of production

and financial assets. A monetary and economic union on the other hand includes elements of

positive integration since it implies common or coordinated monetary, fiscal and sector policies.

This book has a structure based on the typology of economic integration shown in Table 1-1. It

must be mentioned, however, that in the literature on economic integration the meaning of

certain terms may vary. Thus the term monetary union is sometimes used of a group of

countries, which merely have a common currency but do not have a common market or even a

customs union1. Sometimes the term economic union is also used in a broader sense, in which

case it may refer to a group of countries where economic policy is partly a result of joint

decisions or mutual understanding among the members. Economic union described in this way

represents a lesser degree of economic integration than a monetary union.

1-3-3 Stages in the Process of Deepening of the Economic Integration in the EU

1 The monetary unions that existed between Ireland and the UK or between France and its former African

colonies are examples.



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According to the definitions of Table 1-1, the EU, in its present form, is a fully developed

customs union which already has the most important elements of a single market for

commodities and a common market. Moreover monetary co-operation has moved forward by

establishing of a monetary union. Since some sectoral policies are very much the outcome of

joint decisions, and since macro-economic policy will be increasingly coordinated with the

creation of a monetary union, the EU also contains elements of an economic union.

The EU has more or less continually moved towards closer economic integration. Roughly

speaking, the EU moved downwards in Table 1-1, as the customs union was completed in 1968

and the outline of the common market was completed in 1993. The process of integration hashowever at times been interrupted or even reversed. Between 1973, when the first oil crisis

occurred, and the mid 1980s there was almost no progress. The first plan for an economic and

monetary union, the Werner Plan of 1970, was never implemented; but the Delors Plan of 1989

outlined more in details the idea of establishment of an Economic and Monetary Union (EMU)

in the EU. The Delors plan was incorporated in the Maastrict Treaty and in 1999 the EMU was

launched based on the common currency; the euro. However, only a subset of Member States

participated in the euro partly because they have obtained the right to stay outside the EMU and

partly because countries should fulfill the so-called convergence criteria for membership. The

initial group of EMU countries was Austria, Belgium, Finland, France, Germany, Italy, Ireland,

Luxembourg, the Netherlands, Portugal, and Spain. Later this group was expanded by Greece in

2001, Slovenia in 2007, Cyprus and Malta in 2008, Slovakia in 2009 and Estonia in 2011.

1-3-4 The Economic Policy Areas of the EU

Table 1-1 provide for an overall classification of various degrees of integration. As far as the

cooperation goes beyond a customs union policy the condition for a well functioning

cooperation may make it necessary to establish common policies on specific areas i.e. to develop

at least some elements of an economic union. It is apparent from the reviewing the functional

scope of EU-policies.



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Article 3 in the Treaty on European Union gives an overview of the various policy areas, some

of which have hitherto been relatively insignificant, while the following areas of major

importance: (1) the Common Agricultural Policy (CAP), (2) policies concerning the

establishment of the Common Market, (3) the Competition Rules (which also regulate subsi-

dies), (4) the Common Commercial Policy, (5) the Regional Policy and (6) macroeconomic

policies especially related to the Economic and Monetary Union (EMU).

The CAP has traditionally been regarded as the most important EU policy area, at least from an

economic point of view, and it still absorbs over half the EU budget. However, from the mid

1980s, the establishment of a well functioning common market became a central matter, and theEU concerned itself with reducing not merely tariff and quotas on trade but also other

hindrances to the movement of commodities as well as legal barriers to the free movement of

labour and capital. The establishment (in 1992) of the Single Market, which in principle requires

the removal of such hindrances to trade as discrimination in public purchasing and differences in

product standards, is clear evidence of changed policy priorities. The third policy area

supplements the second, for the Competition Rules are a prerequisite for an open and integrated

market in that they limit the misuse of monopoly power and national subsidies in inter-country

commerce.

The Common Commercial Policy means that there is a common external tariff and a common

trade policy towards third party countries. This ensures that a member country can neither obtain

an unfair competitive advantage by importing raw materials or intermediate products more

cheaply than other members, nor profit from cheaper imports which are re-exported to other

members.

The four previous policy areas may to a large extent be justified by considerations of allocative

efficiency, although the rationale of the CAP is also to secure fair living standards for farmers.

The Regional Policy exists primarily to redistribute income from richer to poorer members and

thereby promote economic and social cohesion. Apart from the five major areas, the EU

economic policy has now developed to include transport, energy, social conditions, the labour

market, the environment, the strengthening of industrial competitiveness, research and

technology, public health, education, the developing countries and consumer issues.



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Some of these policy areas such as transport are justified by efficiency considerations, and

others, such as social policy and labour market policy, by both a desire to attain social goals and

a belief that large differences in the area concerned will make it difficult to complete the

establishment of the common market.

Until the establishment of the EMU the EU have had little influence on macro-economic policy.

The Member States were only bound by the loose commitment to ‘regard their economic

policies as a matter of common concern’ (TFEU, Article 121, paragraph 12). However this

situation changed dramatically by the establishment of the EMU at least for those EU countries

which participated in the monetary union. The centerpiece of this cooperation is the commoncurrency the euro and for the euro area the monetary policy and exchange rate policy is

centralized and administered by the new established institution the European Central Bank.

Moreover fiscal policy of the Member States should respect the principle of sound public

finances defined by the Stability and Growth Pact approved by the Europe Council which is the

highest level for decision making consisting of the prime ministers or head of states of the

Member States.

EU policies build on a balance between efficiency considerations and distributional

considerations. In purely economic analyses a trade-off exists between efficiency and equality.

However, in regime optimization between efficiency and distribution more fundamental political

dynamics should be taken into account. If the distribution objective is to be sacrificed to

efficiency in integration there is the risk that the integration process is derailed, and that

economies are segmented again. In the light of this cohesion is a condition for achieving

efficiency through integration.

Table 1-2 summarizes the development of the legal framework of the EU and the associated

landmarks of European integration.

2In the following we refer to the number of Articles after the renumbering of Treaties in TEU and

TFEU.



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Table 1-2 Main historic events of the formation of the European Union

Institution Treaty (year of ratification)

Year of implementation

Landmarks of economic integration

European Coal and

Steel Community

(ECSC)

Treaty of Paris

(1951)

1951 Common policy for coal and steel production.

Members: France, Germany, Italy, Belgium, the

Netherlands, and Luxembourg

European Economic

Community (EEC)

Treaty of Rome

(1957)

1958 Customs union. Free mobility of factors of

production. Members: As ECSC

Euratom Treaty of Rome

(1957)

1958 Non-military utilization of nuclear power.

Members: As ECSC

First enlargement Revised Treaty

(1972)

1973 New members: United Kingdom, Denmark, and

Ireland

Second enlargement Revised Treaty

(1979)

1981 New member: Greece

Third enlargement Revised Treaty(1985)

1986 New members: Spain and Portugal

The Single Market Single European

Act (1986)

1986-92 Formation of the Internal Market

The European Union(EU)

Maastricht Treaty(1992)

1993 Plans for establishing the Economic andMonetary Union at the latest from 1. Jan. 1999.

Formation of the Economic and Monetary Union

1. Jan. 1999 for a subset of EU countries (1)

Introduction of euro notes and coins 1. Jan. 2001

Fourth enlargement Revised Treaty

(1994)

1995 New members: Austria, Finland, and Sweden

The European Union

(EU)

Amsterdam

Treaty (1997)

1998 Obligations for increased efforts to improve

employment


Nice Treaty(2001)

2004 Internal changes in the areas of voting Council judicial reforms and composition of the EU-

institutions

Fifth enlargement Revised Treaty(2003)

2004 New members: Estonia, Latvia, Lithuania,Poland, The Czech Republic, The Slovak

Republic, Hungary, Slovenia, Malta and Cyprus

Sixth enlargement Revised Treaty

(2006)

2007 New members: Bulgaria and Romania

The European Union

(EU)


Constitutional

Treaty (2004)

Lisbon Treaty(2007)

Rejected in

referenda in theNetherlands and

France , 2005

2009

Institutional reforms to increase the efficiency of

the EU-decision making process and to make theEU more democratic and transparent in its

decision making

Contains essential elements of the ConstitutionalTreaty

Note (1): The following 11 EU countries participated in the euro from 1999: Germany, France, Italy, Belgium, the

Netherlands, Austria, Spain, Portugal, Ireland, and Finland. Greece entered in 2001, Slovenia in 2007, Cyprus and

Malta in 2008, Slovakia in 2009 and Estonia in 2011.

Source: Adapted from Table 1-1 in Hansen and Schröder (2001).



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1-4 EXTERNAL AND INTERNAL DIMENSIONS OF THE EU

The EU forms a considerable part of the world economy. Table 1-3 shows a set of key economic

figures which enable both individual EU countries and the EU as a whole to be compared with

the United States and Japan.

It appears from the table that the population of the EU is more than one and half times larger

than that of the United States and nearly 4 times larger than that of Japan. The EU's gross

domestic product (GDP) is slightly larger than that of the United States for 2010 and about 3

times larger than that of Japan. It is important to emphasize, however, that the figures for GDPare not adjusted for differences of price levels i.e. in purchasing power parity. What matters for

differences in living standards is per capita income adjusted for differences of price levels. The

relevance of this appears from Table 1-3 where GDP per capita is reports at current exchange

rates in column 3 but in purchasing power parities (PPS) in column 4. Comparing the figures in

two columns illustrates that GDP per capita at current exchange rates exaggerate considerably

differences in living standards within the EU, underestimate living standards in the USA and

overestimate them in Japan.3

Germany is clearly the dominant EU economy with about 20 per

cent of total EU production, and the four largest EU countries (France, Germany, Italy and the

United Kingdom) have about 63 percent of total EU production.

3

Purchasing power parity theory can be used to calculate synthetic exchange rates so that one ECU, in principle,represents the same purchasing power everywhere. Such alternative are published regularly in the source quoted

in the table.



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Table 1-3 Population, gross domestic product and gross domestic product per capita in EU-

countries, the USA and Japan, 2010

Population(million)

Gross domestic

product(billion euro)

Gross domestic product per capita (indexEU-15=100)

Current exchange

ratePPS

Austria 8.4 281.5 118.3 111.1

Belgium 10.9 351.9 114.1 104.5

Denmark 5.5 232.9 148.2 106.6

Finland 5.4 178.5 117.2 101.1

France 64.8 1,948 105.9 96.9

Germany 81.6 2,490 107.5 107.3

Greece 11.4 229.9 71.2 78.7Ireland 4.5 156.5 123.3 113.9

Italy 60.5 1,548 90.1 91.3

Luxembourg 0.5 40.29 281.2 245.1

Netherlands 16.6 585.7 124.3 117.7

Portugal 10.7 171.4 56.7 70.9

Spain 46.1 1,051 80.4 92.4

Sweden 9.4 347.4 130.9 112.4

UK 62.2 1,694 95.9 104.8

EU-15 398.4 11,307 100 100

Estonia 1.3 14.18 37.3 57.2

Latvia 2.2 17.84 28 43.4

Lithuania 3.3 26.89 28.8 48

Poland 38.2 354.7 32.7 56.2

Czech Republic 10.5 146.3 48.9 73.1

Slovakia 5.4 65.97 42.9 66.2

Hungary 10 98.4 34.6 56.8

Slovenia 2 35.85 62.1 79.2

Malta 0.4 6.1 52 71.7

Cyprus 0.8 17.46 76.6 87.5

Bulgaria 7.5 35.86 16.8 38.2

Romania 21.4 121.7 20 39.7

EU-27 501.7 12.248 86 90.5

USA 310.1 10.923 124.1 132.4

Japan 127.4 4.134 114.3 95.7

Source: EU-Commission Statistical Annex of European Economy, Autumn 2010

1-5 FUTURE PROSPECTS



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Looking back we can see that integration in the EU has continually deepened as co-operation

has become closer and closer, and it has widened with the successive enlargements of

membership. In the treaty on European Union the stage is set for continued development in the

form of both deepening and widening. Article 1 in TEU says that the treaty marks "a new stage

in the process of creating an ever closer union of the peoples of Europe". Article 49 of TEU

emphasizes the openness of the EU by stating that "any European State which respect the values

referred to in Article 2… may apply to become a member of the Union". The possibility to exit is

stated in TEU Article 50, paragraph 1: “Any Member State may decide to withdraw from the

Union in accordance with its own constitutional requirements”.

The continuation of these processes of widening and deepening presents many challenges, for

the members of the EU have different attitudes towards further integration. A major skepticism

among many EU-countries has developed on a further deepening of the EU-cooperation. The

Treaty on European Union therefore now includes as one of their overriding principles the

following subsidiarity clause (Article 5, TEU paragraph 3).

“Under the principle of subsidiarity, in areas which do not fall within its exclusive competence,

the Union shall act only if and in so far as the objectives of the proposed action cannot be

sufficiently achieved by the Member States, either at the central level or at regional and local

level, but can rather, by reason of the scale or effects of the proposed action, be better achieved

at the Union level.”

It should be noted that the article makes it clear that subsidiary applies only to those areas that do

not lie within the "exclusive competence" of the Community. Subsidiary does not therefore

unambiguously support decentralisation; it supports it only where there is no clear argument for

centralisation.



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That widening will take place seems as mentioned previously more probable. Croatia will most

likely soon join the EU and a negotiation for membership for other countries is also expected.

The widening in 2004 and 2007 from 15 to 27 member-countries and the prospects for further

widening has raised a wide spread skepticism that the existing institutional capacity for decision

making in the EU is sufficient. Further widening may therefore block for a further deepening

although the recent Treaties to some extent has addressed this problem in Ability to make

decisions. The dilemma of the choice between widening and deepening is the main political

challenge to further integration in the EU.

1-5-1 A Multi-Speed Europe and a Europe à la Carte Possibly the dilemma of the choice between widening and deepening can be avoided by

renouncing the principle that the EU must have a homogeneous degree of integration and instead

accept either a multi-speed Europe or a Europe à la carte. A multi-speed Europe is one where all

EU members agree on the long term goals of integration, but approach them at different speeds.

In other words each country has individual deadlines for solving the problems of adjustment

brought about by the implementation of measures providing for integration.

Europe à la carte or a Europe with variable geometry refers to an EU where the long term goal

of homogeneous integration is abandoned. The recent Treaties have granted the possibility for

more Europe a la carte. In protocols to the TEU, the United Kingdom and Denmark have got the

option not to participate in the Monetary Union. In general more Europe a la carte has been

allowed by TEU Article 20 paragraph 1”Member States which wish to establish enhanced

cooperation within the framework of the Union’s non-exclusive competences may make use of

its institutions and excise those competences by applying the relevant provisions of the

Treaties…”

A Europe à la carte is easier for an individual country to accept politically, for it can choose to

participate only in those elements of co-operation which it sees as advantageous. The possibility

of enhanced cooperation may therefore ease the frustration of those Member States which have

more ambitious plans for a deeper integration



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However, the disadvantage of Europe a la carte is the risk of serious legal, political and

administrative complications for the institutions and decision making processes of the EU when

different policy areas involve different group of participating countries. The EU Commission is

therefore very reluctant towards such a fragmentation of the Union.

1-5-2 Local Autonomy versus State Autonomy

As emphasized by Alesina and Spolaore (1995), integration can give increased local autonomy

within a nation state, for ties between local areas and the national state are loosened as power

and responsibilities are transferred from the national to the federal level. Local areas have

cultural, economic and political differences which cause them to have their own ideas about theinstitutional framework of their region and such matters as how taxes are raised and on how

money from the public budget should be spent. If a national state is surrounded by trade barriers,

it is of vital importance for the local area to have close ties to the national state, for consumers

and producers need access to a larger market and firms must ensure that their interests are

protected when trade with other nations is regulated. Local areas are also tied to the national

state by the public sector's redistribution of wealth between regions, and they are thus to some

extent protected against a sudden fall in living standards.

Integration in the EU reduces the dependence of local areas on the national state. Every local

area has direct access to the Single Market; transfers direct from the EU via, for example, the

Structural Funds can by-pass the national state; it is the EU which increasingly regulates

agriculture, manufacturing and services; and Monetary Union would subject local areas to EU

rather than national monetary policy. Seen in this light, continued integration of the EU suggests

a Europe of regions rather than a Europe of countries. Such a development would be in harmony

the TFEU, Article 167 which says that "The Union shall contribute to the flowering of the

cultures of the Member States, while respecting their national and regional diversity and at the

same time bringing the common cultural heritage to the fore".

1-6 PLAN OF THE BOOK

The book is divided into three parts: Part I, which is made up of Chapter 1, gives a background

to European economic integration; Part II, which includes Chapters 2-6, analyses the various

forms of economic integration within the framework of welfare and growth theory, while Part III

analyses macroeconomic issues, especially the monetary integration in Europe.



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In Chapters 2 and 3 the welfare effects of removing internal trade restrictions, both visible and

invisible, are analysed, first in the light of perfect competition and subsequently under imperfect

competition.

Chapter 4 deals with some further issues that arise when economic integration is deepened

through the establishment of a common market. Chapter 5 analyses the dynamic effects of

economic integration, i.e. the question of whether the setting up of a common market influences

the growth rate in the EU member states over time. However, as it is not certain that economic

growth will distribute evenly in the various countries, the Chapter will also throw light on theregional economic consequences of integration. Efficiency and distribunal consequences of the

agricultural, competition, subsidy and external trade policies are being discussed in Chapter 6

together with a more fundamental discussion of whether the EU is the right level for pursuing

these microeconomic policies.

Chapters 7-10 deals with macroeconomic issues related to the establishing of the EMU. Chapter

7 discusses, based on the theory of the optimum currency area, the basic rationale for

establishing a currency union. Chapter 8 develops a macroeconomic model for a monetary union

based on external free float of common currency and free mobility of capital. Chapter 9 presents

the frame work for the monetary policy in the EMU. The mighty institution is here the European

Central Bank (ECB) and the competences, institutional set up and experiences on monetary

policy in the EMU are described in Chapter 9. Chapter 10 analyzes the framework for fiscal

policy in the EMU especially the Stability and Growth Pact. The Maastricht Treaty creates an

Economic and Monetary Union (EMU) by 1999 at the latest. Central to these chapters is thus an

analysis of the macroeconomic conditions for the countries who participate in a monetary union.

Participation in a monetary union may influence the countries' GDP, the price level, the balance

of payments, interest and currency rates. The possibilities to influence these variables by

economic policy are analyzed, partly at the abstract level by means of macroeconomic models,

and partly in relation to the factual conditions within the EU.



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Appendix: The EU Budget

This appendix provides a brief presentation of the EU budget i.e. the expenditures and revenue

of EU-institutions. The EU Budget is established in accordance to the following principles and

guidelines:

• Principle of budget balance. This principle is outlined in TFEU Article 310, paragraph

1 which says that ”All items of revenue and expenditures of the Union shall be included

in estimates to be drawn up for each financial year and shall be shown in the budget.

…The revenue and expenditure shown in the budget shall be in balance”

• The basis for establishing the EU-budget is the Financial Framework which is a multi

annual budget of the yearly expenditures for a 7 years period. At present the items of expenditures of the EU annual budget follows from the Financial Framework 2007-

2013. For a detailed description and analysis of the EU-public finance, see EU-

Commission (2008).

The level and main structure of the expenditures is reported in Table A.1 for 2010.

Nearly half of the total expenditures is used to the common agricultural policy (CAP)

while the budget to regional policy (support of least developed countries and regions)

makes up about a third of total expenditures. Administrative costs make up about 8

percent of the total budget. This structure of expenditures is quite stable in the present

financial framework although the share of expenditures related to agriculture decline

slightly while expenditures to support economic growth is on rise, see Table A.3. Total

expenditures make up just about one percent of total EU Gross National Income

throughout all years of the present Financial Framework.

• The budget for revenue should be consistent with overall budget balance and

commitments given by the Financial Framework. Revenue consists of so-called ‘own

resources’ and for a very little fraction of ‘other revenue’, see Table A.3. The own

revenue consists of ‘traditional own resources’ which mostly is tariff revenue from

imports to the EU and member States contribution which is partly related to the tax base

for value added in the Member States and partly the Member States Gross National

Income.



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The tariff revenue depends by and large on external conditions out of control of planner

of the budget. This is also the case for VAT-based contribution, which is calculated for

the individual countries in accordance to a given procedure. Hence, the GNI-based

resource is the ‘residual resource’ which is calculated so it closes the gap between total

expenditures and the total revenue from the other sources of revenue. The GNI

contribution in 2010 covers about 75 percent of the total budget while the VAT

contribution and the ‘traditional own resources’ only make up 11- 12 percent each of the

total budget. Similar to the expenditure structure the structure of sources of revenue is

quite stable from year to year.

•

Overall budget constraint. In the Financial Framework impose an overall ceiling ontotal own contribution to GNI. In the present Financial Framework the ceiling of ‘own

resources’ to GNI is 1.24 percent. This leaves a small margin between the ceiling of

total ‘own resources’ and total planned expenditures in accordance to the Financial

Framework, see Table A1.

Table A.1 Expenditure of the EU, 2010

Billion Percent of

Euro total expenditureSustainable growth

• Competitiveness for

growth and employment(1)

14.2 10

• Cohesion for growth and

employment(2)

49.4 35

Preservation and management

of natural resources (3) 60.0 43

Citizenship, freedom, security

and justice (4) 1.7 1EU as a global player 7.9 6

Administration(5)

7.9 6

Total planned expenditures 141.0 100

Notes: 1) Such as expenditure to research and development, education and training and trans – European

networks, 2) Support of the least developed countries and regions, 3) Most of these expenditures are related to

the common agricultural policy (CAP), 4) Expenditures to justice and home affairs, border protection,

immigration and asylum policy, 5) Expenditures to external actions including pre-accession support, (6)

Administrative expenditures for EU-institutions

Source: http://ec.europa.eu/budget/prior_future/fin_framework



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Table A.2: The Financial Framework 2007-2013

Percent of total expenditures

2007 2010 2013

Sustainable growth• Competitiveness for

growth and employment 7 10 10

• Cohesion for growth and

employment 36 35 36

Preservation and management

of natural resources 44 43 40Citizenship, freedom, security

and justice 1 1 2

EU as a global player 5 6 6

Administration 6 6 6

100 100 100

As percent of total EU Gross National Income (GNI) 1.02 1.18 1.14


Table A.3 Revenue of EU, 2010

Billion Percent of

Euro total revenue

‘Own resources’

Traditional own resources 14.1 12

(customs duties from inputs)

Member State contribution

related to:

• Value added tax revenue 14.0 11(VAT-base)

• Gross National Income 92.7 75

(GNI-base)

Other revenue (1) 2.1 2

Total revenue 122.9 100

Note: 1) Tax on EU – salaries, proceeds from sales of EU properties, fines etc




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REFERENCES

Alesina, Alberto and Spolaore, Enrico (1995), On the Number of Nations. Working Paper

No.5050. National Bureau of Economic Research. Cambridge, Massachusetts.

Hansen J., D. and P., H. Schröder (2001) ‘Economic Integration in Europe: Setting the Stage’,

chapter 1 in Hansen J.D. (ed), European Integration: An Economic Perspective, Oxford

University Press, Oxford

EU Commission (2008), European Union Public Finances, 4 ed. Bruxelles.

http://ec.europa.eu/budget/library/publications/financial_pub/EU_pub_fin_en.pdf

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