Chapter 35 European integration David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith Some key issues ■ The European Single Market – ■ Economic and Monetary Union (EMU) – – ■ what difference did it make? why did it happen? What difference will it make? Reform in Eastern Europe – how are these countries faring in their transition from central planning to market economies? 35.2 The Single Market with December 1992 as the target date for completion – which was met 6000 400 350 5000 300 4000 250 3000 200 150 2000 millions ■ Established under the Single European Act of 1987 billions of ECUs ■ 100 1000 50 0 EU USA Japan GDP (LH scale) Population (RH scale) 35.3 Objectives of the Single Market ■ Abolition of remaining foreign exchange controls on capital flows ■ removal of non-tariff barriers within the EU ■ elimination of bias in public sector provisioning ■ removal of frontier controls – ■ with some provisos progress towards harmonization of tax rates 35.4 Benefits of the Single Market ■ Improved resource allocation – ■ Scale economies – ■ larger potential market increases the scope for economies of scale Intensified competition – ■ removal of non-tariff barriers allows more exploitation of comparative advantage may stimulate greater cost efficiency Factor mobility – enables greater efficiency through mobility of labour and capital 35.5 Gains from the Single Market % of initial GDP 25 20 15 10 F, D, I, UK Den Low 2 High NL, Sp B,Lux Ire Gr Port 4 19 10 16 20 Source: Allen, Gasiorek and Smith (1998) 35.6 From EMS to EMU ■ ■ A monetary union has – permanently fixed exchange rates within the union – an integrated financial market – a single central bank setting the single interest rate for the union The Maastricht Treaty set criteria for EMU entry – ■ to define ‘convergence’ The single currency area began in January 1999 with 11 member countries 35.7 The Maastricht criteria ■ Inflation rate – ■ Long-term interest rate – ■ in the narrow band of ERM for years Budget deficit – ■ no more than 2% above the average of the lowest EMS countries Exchange rate – ■ no more than 1.5% above the average of the inflation rate of the lowest countries in the EMS no larger than 3% of GDP National debt – no greater than 60% of GDP 35.8 Sterling and Europe UK membership of ERM/EMU? UK trade patterns North Sea oil made the UK different The UK is less integrated with the rest of Europe – but this is changing % of UK trade 60 50 40 30 20 10 The UK has a greater tradition of macroeconomic sovereignty Black Wednesday and the ERM crisis The UK’s business cycle was out of phase with the rest of Europe 1972 1998 35.9 The economics of EMU ■ Optimal currency area – ■ a group of countries better off with a common currency than keeping separate national currencies key attributes (Mundell) – – – countries that trade a lot with each other countries with similar economic and industrial structures flexibility in labour markets 35.10 So is Europe an optimal currency area? ■ Europe is ‘quite’ but not very closely integrated ■ Some countries are more closely integrated than others ■ but the act of joining may itself feed the process of integration 35.11 Macroeconomic policy for a small member of Euroland A small Euroland member faces a horizontal LM curve, given that interest rates are fixed by the ECB Suppose an external shock moves the IS curve to IS1 If the country is too small to influence the ECB to alter interest rates, either the country must wait for wage & prices to shift IS back via improved competitiveness, IS1 IS0 LM r0 or fiscal policy will be required to enable more rapid adjustment Y1 Y0 35.12 Central and Eastern Europe GDP per capita in 1988/89 5000 10000 15000 20000 US$ 35.13 Eastern Europe: some key issues ■ ■ On the eve of transition – low per capita income – high international debt Supply-side reforms – ■ ■ crucial for prices to reflect true scarcity Trade and foreign investment – markets needed for products – and physical capital/management skills Macroeconomic conditions – firm and credible macro policy needed – especially to avoid excessive inflation 35.14 10 1998 1997 1996 1995 1994 1993 1992 -5 1991 1990 700 600 500 400 300 200 100 Growth of real GDP Inflation % p.a % p.a A progress report on the transition -10 -15 Hungary Romania Poland Bulgaria Hungary Romania Poland Bulgaria 35.15