European Economic Integration

This book investigates the evolution of the integration process of the European Union (EU) under the lenses of economic development. The process of the European Economic Integration is an innovative experiment, unique in its magnitude, breadth and depth. While the number of regional associations has increased immensely in recent decades, the EU remains the union with the largest number of member-states and the most pronounced transfer of powers to supranational institutions. This degree of integration, combined with the relative importance of the continent in global wealth and trade, imparts paramount influence not only for Europe itself but for the whole world at the political, social and economic level. Thus, the study of this evolution is a special challenge both for economists and for European citizens trying to appreciate the extent to which this transfer of power benefits (or not) Europe as a whole, each Member-State separately, third countries and the global economy. The originality of the book lies in its effort to combine three levels of analysis and explore their interaction in real life:

• The state-of-the-art of the theoretical background of the scientific fields relevant for policies of European competence.
• The governance and policy developments during the 60 or so years of the integration process.
• The evaluation of the results of European policies from an institutional as well as from an academic perspective.

The reason behind studying the interplay of these three levels has to do with multiple curiosity captured in the following questions: Is this supranational authority, in general benefitting of sufficient human capital following the recommendations of new academic insights? If policy proposals do take the development of recent academic research into consideration, are they embraced by policy makers or is it simply the result of multilateral negotiations and the need for consensus of a variety of national and vested interests leading to their attenuation and alienation? Last but not least, do academic and institutional evaluations coincide, and what do they teach us about either the policy relevance of theory or the theoretical underpinning of policy?

Methodologically, the research is presented by policy area, after starting with an introduction of history and governance, which helps apprehending the individual politics of the decision making process against the rationale of collective long term gains. The complex decision making process of 28 sovereign Member-States, the strict competition regime including state-aid rules and the almost negligible (<2% of GDP) budget of the Union are the background knowledge that enables us to clarify policy progress. Then each chapter deals with the major policies starting with those with a purely supranational character (Single Market, International Economic Relations and Agricultural Policy), followed with the variable geometry of the Economic and Monetary Union (EMU) and finally the policies of shared responsibilities (Competitiveness, Regional Development and Social Policy).

Besides the political will of unification for peace, the Internal Market was created following the (at the time) modern theory of customs unions piloted by J. Viner and by R.G. Lipsey. The expectations of growth caused by trade creation, economies of scale and specialisation were the main drivers of the integration of the six initial Member-States. The theory was accepted but the expected gains of the most competitive countries (Germany and the Netherlands) were counterbalanced by the demand of France for a protectionist agricultural policy, with political but not theoretical underpinning, and the demand of Italy for the free movement of production factors, supported by the Hecksher-Ohlin-Samuelson arguments. By and large, theory matched well the political agenda of the ‘60s. The protection of agricultural was a concession to a large Member-State and an exception to arguments in favour of the best allocation of resources. Economic policy during the remarkable post-war growth complied with the liberalisation of trade; however, the Member-States were slow and reluctant to comply with the liberalisation of labour and capital. Although evidence was in favour of gains from the integration process and the theory did not change, the economic crisis of the ‘70s led to a retrogression of the market unification, known as neo-protectionism, namely a process of discouraging intra-community commerce not through tariffs but through regulatory and other barriers to trade. Meanwhile evaluations demonstrated that gains from the unification were high but unevenly distributed at the cost of the less competitive countries. Paul Krugman’s, Helpman’s and others’ seminal work on new trade theory and new economic geography were on time to inspire an upturn in the unification process in the ‘80s, after the oil crisis waned out. The Internal Market was complemented with the conclusions of the new theory: transfer of regional development funds was added to the free movement of goods, services and factors of production. Unlike the uni-dimensional Internal Market, the Single Market has two pillars, growth and distribution, thanks to theory and evidence. However, theory did not prescribe either the adequate size or the optimal governance of fund transfer. Intra- community trade in goods is by now so intense that there is no doubt that it shapes European specialisation; trade in services is increasing to reach a similar pattern. Conversely, the free movement of labour is still limited and hampered by national regulations and consumer preferences, whereas the free movement of capital is complete but not thanks to internal rules, it rather follows global trends. Hence, the free movement was completed and a separate policy chapter, Regional Development Policy was opened.

Trade and development theory are relevant not only for the internal market but also for the trade, investment and aid relationships with third countries. European economic relations are different vis-à-vis developed and developing countries. Developed countries constitute suppliers, clients and competitors at the same time and economic relations are characterised by the dominance of market forces, limited regulation and protection. A potential preferential agreement, following the mature custom union theories, is negotiated with the US, but differences and interests lead to very slow progress. Conversely, the EU follows G. Myrdal’s, S. Kuznets’s, A. Lewis’s and D. North’s ideas on the necessity of not only transferring funds to developing countries but most importantly addressing the way these funds are spent: to support industrialisation, capacity building and last but not least a sound governance and institutional set up. Hence, in two specific blocks of developing countries, namely the former colonies of the Member-States (African, Caribbean and Pacific Group of States) and the neighbouring hinterland of North Africa and Western Asian (MEDA countries) there are long-term preferential agreements. More recently preferential agreements are devised with a set of neighbour countries as well (Western Balkan and CIS). The relationship with these countries is based on unilateral trade concessions, incentives for industrialisation and development aid focusing not only on infrastructure but also on human capital and institutional change. Despite a rhetoric of openness to international trade and support to development, academic research indicates that the EU remains protectionist, wherever this is relevant to specific interests while there is more rhetoric in its development aid than real intervention: transfer of funds is limited and while nominal protection is low, effective protection was in certain cases identified to be high. The highly protective agricultural policy is an additional focus of criticism. The EU, still being a dominant figure, is losing out in terms of its share in global trade and investments. The causes of this can be found partly in the successful performance of traditional and emerging competitors and partly in competitiveness policy in the EU.

In terms of supporting production, agriculture was always protected, absorbing a significant share of the limited EU budget, a compromise between lobbies and Member-States notwithstanding dominant theories. Conversely, industrial policy was never a supranational responsibility with the exception of coal and steel, a declining sector in developed countries. At the time of creation of the EU, the manufacturing sector was growing fast and hence the initial Treaty of Rome, in agreement of the business sector and policy makers, left it to the market forces, ensuring only free competition rules. This was in line with the free trade and anti-trust dominant doctrine of industrial organisation at the time. Over time, competitive pressures from both developed and emerging countries, the successful intervention policy of Japan, South Korea and the newly-industrialising countries of the ‘80s and last but not least the information and communication technologies (ICT) revolution leading to the knowledge economy changed the cornerstone of industrial policy. The endogenous growth paradigm promoted by P. Romer and R. Lucas and the universal recognition of the relevance of increasing returns to scale changed global policies and recognised the relevance of intervention to eliminate market failures in research, innovation and human capital development. The shift from manufacturing to (business-related) services and the new intervention tools suggest a Competitiveness rather than Industrial policy, which was formally adopted by the EU in the year 2000. However, as internal growth is not a supranational responsibility the European intervention could only be complementary and voluntary. It is composed of invectives for Research, Development and Innovation (RTDI) and an Open Method of Coordination (OMC). The former has very limited funds available, but they are constantly increasing, as shares of the EU budget, to comply with persistent theoretical evidence of the relevance of RTDI. The literature on market failure, systemic failures, externalities, cluster creation, innovation procurement, open innovation etc. are always rapidly taken over into the incentive portfolio of the European Commission. The latter is a light but structured way EU Member-States use to cooperate at European level for exchanging good practice on the way they design policies and funding schemes. The benefits of the EU policies for the competitiveness of the Member-States is diverse, highly correlated with pre-existing competitiveness and connected to Regional Development Aid in some cases. Less competitive regions and weaker social classes are losing out.

Cohesion policies were conceived to make up for the initial backwardness in regional and social terms and target potential inequalities that are reinforced by the Single Market and competitiveness policies. Regional development and social policy and distinct funds are dedicated to the two interrelated policies. They do, to a large extent, comply with theory: Flexibility notions of Piore and Sable, New Competition prerogatives and the renaissance of agglomeration economies advocated by M. Porter, M. Best and the Italian literature on industrial districts have dominated the prescription of regional development policies. At the same time political science prescriptions on the recipient embracing donors’ policies has led to the adoption of the principle of subsidiarity (taking decisions at the administratively lowest possible level), which has shifted the balance towards regional vested interests rather than top down policy selection. Cohesion policies have had very mixed outcomes: overall economic convergence and social cohesion improve in times of stable economic growth but regress during crises. This is not universal: there are exceptions to that in both directions: some regions have persistently grown out of their less prosperous status, while others are relatively deteriorating. Economic and social inequality are sometimes increasing during growth periods as well.

Finally, the EMU, which has been created following strictly the general guidelines of the Mundell and Mc Kinnon theory on optimal currency areas, has adopted nominal convergence criteria only. To the defence of policy makers, theory did not make more detailed recommendations and the implementation of the rules had to be decided at the policy level alone. The decision to integrate monetary but not fiscal policy has created the asymmetric shocks triggered by the 2008-2013 economic crisis and evaluations are too recent to converge on the costs and benefits of the EMU and the mechanisms created ex post and almost ad hoc to mitigate the effects of the crisis.

The evidence that Citizens and Member-States constantly seek to assess the costs and benefits of their participation in the European Union really cannot be provided, let alone be quantified with counterfactual scenarios. The book tries to clarify theoretical and political interactions demonstrating that the integration process is everything but smooth and uni-directional. In periods of economic growth integration is deepening, gaining momentum and emerges politically reinforced with more supranational powers. In periods of crisis this is reversed and Euroscepticism prevails but there is no formal return to national regulation, where the EU has taken over. Most recently, the intensity of the crisis of 2009-2013, the divergence of the South and the deteriorating social cohesion provoked reactions, which can be summarised as follows:

1. Within the EU there is no real solidarity; regional divergence, increasing social exclusion and the lack of fiscal policy constitute undisputable evidence.
2. In terms of competitiveness, Europe is gradually losing its advantages and shares in international trade and foreign direct investment.
3. The governance of Europe, which began with visionaries and is sensitive to economic theories, by and large evolves into a highly bureaucratic organisation dominated by the need to find consensus to national and vested interests.

This criticism, which is in several cases evidenced by academic research is sometimes fair and in other instances unfair. The research assumptions used and the global competitiveness forces influence the outcome of every research and evaluation. Europe is currently facing big challenges and big dilemmas, more often than not created beyond its borders. This book does not attempt to provide solutions. Its ambition is to cite the theories and facts in a way that will help the reader to better understand and assess the evolution of European integration. Ideally it will stimulate more research in the interaction of theory and policy.