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European economic policy

European Economic Policy (Università Commerciale Luigi Bocconi)

Studocu is not sponsored or endorsed by any college or university

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LECTURE 1: 7.02

CONTENTS:
1. EU in the global arena
2. EU history
• Widening • Deepening
3. EU Institutions
4. EU law and decision making

China high GDP. But the denominator is big (lots of people).

Europe is an important market. European Union is considered as

one entity.

Trend: EU is blue line. Japan is going down.

China most brilliant performance. Brazil and Russia are

mainly exporters of commodities so exposed to fluctuations.

In trade EU is the third. Important Role. More bargaining power in being together. More strength, but needs
a compromise. One agenda. Different countries with different interests.
Size of the market: how attractive you are.

Fist aim: expand EU market. No restrictions within the EU.

EU is an open entity in the world trade. Because EU needs energy…

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Believes in free trade, but there is only one area that EU doesn’t like a
lot -> agriculture.

Virus, climate change, energy, technology.

Decision making in EU not common.

The European Union vs. the rest of the world

The EU accounts today for around 7% of the world population, but around 22% of world GDP (19% without
the UK), similar to the US, and China.
But it also accounts for 50% of total welfare expenditure in the world.
The EU generates between 20 to 25% of world trade flows (not including intra-EU trade, in which case the
number increases to 35%).
Through its single currency, the Euro, the overall size of EU financial markets is about 1205 of the US one,
with 50% of world bank assets.
Bottom Line: the EU is one of the three large markets of the world, the largest trading partner, and key player
in financial markets, with the most advanced welfare system and living standards.

Dimensions of EU development

Widening (enlargement)
Decisions of State. No-one is forced to join. There are some criteria to
fulfill.
After second world war, seven countries (Italy, France, Germany,
Luxembourg,
Then UK.
After collapse soviet Union-> Hungary, Poland…
Member state are the shareholders of the EU, the core.
There are meetings between them.

The early steps: 1945-1957

At the end of WWII, European leaders wanted to avoid a new similar tragedy -> nationalism had to be
defeated by creating something like the United States of Europe.
The US offered financial assistance if countries agreed on a joint programme for economic reconstruction:
Marshall Plan (1948).
Marshall Plan: help from USA to EU, with the obligation to reconstruct economy, and help also Germany.
The second aim was to eliminate the Soviet Union, and make the influence less strong.
As Cold War got more war-like, West Germany rearmament became necessary. But strong and independent
Germany was a scary thought for many; best to embed an economically and militarily strong West Germany
into a supranational Europe.

Treaties: legal text where states allocate what they have to do together.
Usually Treaties have two dates. One is of the signature, and the second is the entry to force.
ECSC (treaty of Paris, 1951)-> supranational institutions only for two goods, coals and steel, controlling who
is doing what about these two goods. Belgium, France, Germany, Italy, Netherlands and Luxembourg (the
‘Six’) place their coal and steel sectors under the control of a supranational authority => controlling German
rearmament.
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EEC-> treaty that covers almost everything, agriculture, services, trade, competitions… capital, people,
goods, services. Riding on the success of the ECSC, the Six committed to form a customs union with four
fundamental freedoms and common policies.

When you write a treaty you write the aim of it. Requires time to get there. Not an immediate aim.

By the late ’60: two non-overlapping circles

There are two blocks:
one EEC (Belgium, France, Italy, Luxembourg, Netherlands and West Germany)
and the other EFTA (Austria, Denmark, Norway, Portugal, Sweden, Switzerland and the United Kingdom).
They share the aim of free trade. One has a tariff the other no. but these two blocks started to have different
pattern.

Evolution to two concentric circles: the domino effect.

- Falling trade barriers within the EEC and within EFTA lead to discrimination (ex. British firms exporting
to Germany had to pay tariffs, French exports to Germany were tariff-free)
- The GDP (potential market size) of the EEC much larger than that of EFTA, and EEC incomes were
growing twice as fast.
- Thus, the EEC was far more attractive to exporters and this lead to new political pressure for EFTA
nations to join the EEC.
- The UK applied for membership in 1961 and Denmark, Ireland and Norway also followed since they
would otherwise face stronger discrimination (other EFTA nations did not apply because of political
reasons).
- Charles De Gaulle stopped UK membership, twice in the 60s. Ultimately Denmark, Ireland, and UK
joined in 1973, while Norwegians said no in a referendum.
- With the first enlargement (1973), the EEC moved from 6 to 9 members while the EFTA maintained the 7
members thanks to the entrance of Iceland and Finland (however much smaller than Denmark and the
UK).

- Thanks to positive political development, Greece joined in 1981 (EEC10), Spain and Portugal in 1986
(EEC12).
- Deeper integration in EEC strengthened the ‘force for inclusion’, in remaining EFTA nations
- The European Economic Area (EEA) initiative was launched in 1989 to extend European single market of
the EEC to remaining EFTA nations. Today, the EEA is made of 27 members of the EU and three of the
four member states of the EFTA (Iceland, Lichtenstein, Norway).
- The fourth enlargement adds Austria, Finland, Sweden in 1995 and leads to the EC15 (with the Maastricht
Treaty, 1993, the EEC was renamed the European Community to reflect that it covered a wider range than
economic policy).

The fall of the Berlin Wall and of the Soviet Union

At the end of WWII, while the US was providing aids to western Europe under the Marshall Plan. The
Soviets had installed left-wing governments in the countries of eastern Europe liberated by the Red Army.
The Warsaw Pact was a collective defense treaty established by the Soviet Union and Albania, Bulgaria,
Czechoslovakia, East Germany, Hungary, Poland and Romania. The Warsaw Pact embodied what was
referred to as Eastern bloc, while NATO and its member countries represented the Western bloc.
This changes at the end of the ‘80s
- End of the 1989: democracy in Poland, Hungary, Czechoslovakia; fall of the Berlin Wall (built in 1961)
- 3 October 1990: German re-unification
- End of 1990: independence of Estonia, Latvia and Lithuania
- End of 1991: the Union of Soviet Socialist Republics (USSR) itself breaks up
- The cold war ends and, with it, the military division of Europe ends.
Reuniting east and west Europe
At first, no promise of membership but free trade agreements with promises of deeper integration and some
financial aid.
In June 1993 the European Council set the Copenhagen criteria for accession of Central and Eastern
European Countries (CEECs):
1. Political stability of institutions that guarantee democracy, the rule of law, human rights and respect for
and protection of minorities;

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2. A functioning market economy capable of dealing with the competitive pressure and market forces
within the Union;
3. Acceptance of the Community ‘acquis’ (EU law in its entirety) and the ability to take on the obligations
of membership.
CEEC nations plus Cyprus and Malta joined the EU in 2004 followed by Romania and Bulgaria in 2007.
The three Copenhagen criteria still apply today.
Copenhagen criteria: conditions to fulfill in order to join the EU.

Becoming a member of the EU:

Prerequisites:
1. The country must be “European” (art. 49 TEU) and should sign an Association agreement with
accession clause.
2. The country must send the application that needs to be approved by the Council of the EU (unanimity)
after consulting the Commission and after receiving the consent of the European Parliament.
3. The country must meet the first two “Copenhagen criteria”:
- Political stability of institutions that guarantee democracy, the rule of law, human rights and respect
for and protection of minorities
- A functioning market economy capable of dealing with the competitive pressure and market forces
within the Union.
4. The country must incorporate the “Community acquis”, EU law in its entirety, (the third “Copenhagen
criterion”) currently divided into 35 different policy fields (chapters) - such as transport, energy,
environment - each of which is negotiated separately.
5. The Accession Treaty, drafted bu the Commission, must t be voted by the Council of the EU and the
European Parliament, and ratified by all the Member States + the Acceding Country.

Becoming a member of the EU: the procedure

-Throughout the negotiations, the
Commission monitors the candidate's
progress in applying EU legislation and
meeting its other commitments, including any
benchmark requirements.
-This gives the candidate additional guidance
as it assumes the responsibilities of
membership, as well as an assurance to current
members that the candidate is meeting the
conditions for joining.
-The Commission also keeps the EU Council
and European Parliament informed throughout
the process, through regular reports, strategy
papers, and clarifications on conditions for
further progress.

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Recent enlargements in number

The percentage change of the expanded EU compared to the existing
one.
GDP in the last enlargement was lower. This is relevant for the
budget allocation of goods.

The big enlargement (2004) after the Cold War

Romano Prodi, President of the European Commission, 1 May 2004
(…) For many long years we have been preparing the ground for the accession to the European Union of
these 10 countries from central and eastern Europe and the Mediterranean.
The negotiations we have conducted, while difficult at times, bear witness to our common commitment to
unify our continent and finally to end the artificial division the Iron Curtain imposed on us for more than half
a century (Soviet Union collapsed on 1991).
(...) I want to pay tribute to the peoples of Europe who are joining us today. Even in the darkest days of
Stalinism, they never lost hope. Since the fall of the Berlin Wall (1989), they have carried out a quiet
revolution based on the democratic values that are our common heritage today.

EU enlargement: others
The enlargement of the EU is not over.
The enlargement also deeply changed the institutional working of the European Union, given the higher
number of countries / variety of interests / economic development. As such, it required the EU to reform its
institutions, ultimately through the Lisbon Treaty (signed in 2007, into force in December 2009). Due to the
challenges posed by 2004 enlargement, notwithstanding the commitments made to the countries already in
the process, the European Council (December 2006) agreed on considering carefully the EU’s capacity to
integrate new members: the EU should be more cautious in assuming any new commitments.

The Case of Ukraine

- On 28 February 2022(4 days after Russia’s invasion),Ukraine sent its application for EU membership.
- On 17 June 2022, the European Commission presented its Opinions on the application for EU
membership submitted by Ukraine, Georgia and the Republic of Moldova.
- Based on the Commission’s opinion on the country’s application for EU membership, Ukraine was given
a European perspective and granted candidate status on 23 June 2022 by unanimous agreement between
the leaders of all 27 EU Member States.
- Candidate status was granted on the understanding that Ukraine take some key steps (eg, approval of
transparent selection procedure for judges of the Constitutional Court of Ukraine, fight against corruption,
anti-money laundering legislation).
- The Commission will monitor their progress in fulfilling these steps and report on them, as part of its
regular enlargement package.

The Case of Türkiye

- Türkiye (population 84 million) is a candidate country. It applied for membership in 1987, and it was
declared eligible in 1997 (i.e. it satisfies the political and economic Copenhagen criteria).
- Türkiye involvement with the EU goes back to 1959 and includes the Ankara Association Agreement of
1963, for the progressive establishment of a Customs Union, then completed in 1995 => EU and Türkiye
have free trade among themselves and share the same structure of tariffs with respect to the rest of the
world.
- Accession negotiations started in 2005, and in 2018 the Council froze accession negotiations.
- Why? The EU has serious concerns on the deterioration of democracy, the rule of law, fundamental rights
and the independence of the judiciary. However the formal reason is that Türkiye refuses to recognize the
Republic of Cyprus and it has not removed all obstacles to the free movement of people (Türkiye
continues to apply a discriminatory visa regime against nationals of Cyprus, while it has abolished the
short-stay visa requirements for the other 26 Member States) goods, including restrictions on direct
transport links with the Republic of Cyprus.

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LECTURE 2: 9.02
Schengen area-> free circulation of people, no passport check.
NATO-> used to be obsolete, because its aim was to eliminate the Soviet Union.

The European Political Community (EPC) was called by French

President Macron after Russia’s invasion of Ukraine in February 2022,
to serve as a forum for political dialogue and cooperation on
security, stability and prosperity.
The EPC held its inaugural meeting on 6 October 2022 in Prague with
the leaders of the EU's 27 Member States and 17 other European
countries (eg. Ukraine, Turkey and the UK) focused on the war and the
energy crisis.
The EPC will meet twice a year, meeting next in Chişinău (Moldova)
in Spring 2023.

Concentric circles shaping the EU in the future?

Widening is about who is in,

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Deepening (policies at EU level)

The EU has only the competences conferred on it by the Treaties:

Supranational vs. intergovernmental

The economic integration starts with a free trade area and customs union, which the six founding members
of the European Economic Community (EEC) had accomplished by 1968, as well as the gradual build-up of
the European Internal Market based on:
- Four fundamental freedoms: free flow of goods, services, workers and capital. In this common/single
market, firms and consumers located anywhere in the area would have equal opportunities to sell or buy
goods and services throughout the area, and owners of labour and capital should be free to employ their
resources in any economic activity anywhere in the area.
- Common policies where necessary: the EU acts only within the limits of the competences that EU
countries have conferred upon it in the Treaties; thus competences not conferred on the EU by the Treaties
thus remain with countries (Social policies, welfare, taxation remain in the hands of national
governments).
- Common rules: the development of a body of law harmonising rules and procedures throughout the area.
- During these years, some degree of coordination of, for instance, monetary and exchange rate policies
was also set up alongside a number of institutions, laws and decision-making processes.
- Given the final goal of a fully-fledged common market, this process was not too far from being
completed in the early 1990s, though additional work needed (and still needs) to be done to complete the
Internal Market.
- The Union Era is characterized by the Economic and Monetary Union (EMU) and the single currency, the
euro.

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- However, the initial version of EMU, despite including some mechanisms for
the coordination of national economic policies, proved unable to cope with the shocks emanating from
the global crisis and even contributed to endogenously creating some of the preconditions for the euro
area crisis.
- A paper published in 2015 presents a quantitative index of EU integration since the 1950s. It is
articulated along two overarching periods of institutional integration: (1) The “Common Market
Era”, from 1958 (when the Treaty of Rome entered into force) until 1993 (when the Treaty of Maastricht
entered into force);
(2) The “Union Era” from 1993 to 2014.
- The graph in the next slide summarizes the deepening of the European integration project.
- The brown line is the maximum score achievable if all objectives of the Common Market Era and of the
Union Era were fully accomplished: it is 50 from 1958 to 1993 and 100 (50 + 50) thereafter.

Deepening: the omitted elements

- The EU is about single market, single currency, common policies (ex. Trade, competition, agriculture,
currency…), but…
- Social policy (welfare, health, education, labour market regulation, pensions) and taxation are mostly
national policies apart from the framework, not the rates, of indirect taxation: the Value-Added Tax
(VAT).
- Harmonization in those fields is politically difficult. EU nations have very different sensitivities on what
types of social policies and taxes should be dictated by the government.
- However, is a top-down harmonization necessary?
- In low-tax countries workers will enjoy a higher net salary compared to
high-tax countries.
- Since low-tax countries are also low-welfare countries, workers need to
buy, with their net salary, services that are not provided by the
government (education, health, transportation...).
- National wages would adjust to offset any unfair advantage.
- The VAT is a consumption tax assessed on the value added in each production
stage of a good or service. Every business along the value chain receives a tax
credit for the VAT already paid. The end consumer does not, making it a tax
on final consumption.
- EU law only requires that the standard VAT rate must be at least 15% and the
reduced rate at least 5% (usually for foodstuffs).
- Actual rates applied vary between EU countries and between certain types of
products.

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The key principles of the EU

Though the powers of the EU have expanded (deepening), the aim of the EU is not to intervene in every
field. The exercise of EU competences is subject to three fundamental principles:
1. The principle of conferral: the EU may only act within the limits of the competences conferred upon it
by the EU countries in the Treaties to attain the objectives provided therein.
2. The principle of subsidiarity: in the area of its non-exclusive competences, the EU may act only if the
objective of a proposed action cannot be sufficiently achieved by the EU countries, but could be better
achieved at EU level (put it another way: the EU does not take action, unless it is more effective and
efficient than action taken at national, regional or local level).
3. The principle of proportionality: the content and scope of EU action may not go beyond what is
necessary to achieve the objectives of the Treaties.

An example of the principle of subsidiarity

The EU has responsibility when transport is of transnational nature, like the setting up of common
infrastructures and transport corridors (TEN-T) and the harmonization of technical and administrative
standards among Member States.
Urban transport (e.g., regulation of taxis) is in the hands of national and local authorities. The Court of
Justice of the EU (CJEU) ruled that Uber should be classified as a taxi service and not a digital platform.
Uber directly offers a transport service, and without the Uber app, the drivers would not be able to offer that
service. Uber has decisive influence over the price.
So, for example, Uberpop is banned in Italy, Germany and France, but it works in Czech Republic, Estonia
and Poland.

The ‘big’ EU institutions

European States created and want to be part of the EU to manage some policies together.
There are many EU institutions but the core ones involved in the legislative process are 5:
1. The European Commission
2. The Council of the EU
3. The European Council
4. The European Parliament
5. Court of Justice of the European Union (CJEU)
Other important EU institutions are, among others: the European Central Bank (ECB, responsible of
monetary policy in the Euro area), the EU Court of Auditors (that oversees the correct execution of the EU
budget).

The European Commission

The Commission can be seen as the executive-bureaucratic arm of the EU. Has a key role in managing EU
finances: collection of revenues, proposal of yearly EU budget and administration.
Promotes the general interest of European integration, in light of the Treaties.
Develops proposals for new laws and policies: “powers of initiation”.
Oversees the execution of adopted laws and policies (ex. The Commission can take to the Courts of Justice
any member state, corporation or individual that acts against the EU law).
Represents the EU in international organizations like the World Trade Organization (WTO).
The College of Commissioners is made of 27 members, one for each country.

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Each commissioner is responsible for a different area of policy (ex. Environment, trade, competition,
regional policy, external relations…)
The college serves a five year term.
The College is headed by a President, currently Ursula von Der Leyen, the former Germany’s Federal
Minister.
The President of the Commission: (1) Distributes portfolios among Commissioners, (2) Sets the agenda of
the Commission and chairs the meetings, (3) Can launch major new policies, (4) Represents the Commission
when dealing with other EU institutions or national governments.

The Council of European Union

Consists of national government ministers, who meet in 10 different “councils” (configurations), depending
on. The topic under discussion.
One of the most important configurations is the “ General Affairs”, bringing together all the EU foreign
affairs ministers to discuss issues related to internal EU affairs, sensitive policies and new laws, preparing the
meetings of Heads of State and Government (European Council).
The “ Economic and Financial Affairs Council” (Ecofin) brings together the economics and finance
ministers.
The relevant EU Commissioner also attends the meetings.
The frequency varies depending on the configuration, from once per month (Ecofin…) to once every six
months (Agriculture…).
Extraordinary meetings, beyond the agenda of the Presidency, can be set should the need arise.
The Presidency is held in turn by each member state for a period of 6 months (changes in January and July
every year), now Sweden (the official website).

Together with the Parliament, the Council of the EU is a key decision-making actor. It discusses, amends and
approves (or not) new laws which are proposed by the Commission.
The Council deliberates with
Simple majority: for procedural issues
Qualified Majority Vote (QMV): most common mode. To be successful, a proposal must win a double
majority of at least 55% of member states (15/27) and 65% of total population.
Reverse Qualified Majority Voting (RQMV): Decisions on most sanctions under the Excessive Deficit
Procedure (fines for national governments) are deemed to be approved by the Council of the EU unless a
qualified majority of Member States overturns them.
Reverse Reinforced Qualified Majority: At least 72% of MS (20/27) representing at least 65% of the EU
population are needed to object to the Delegated Act: ie, non-legislative acts adopted that serve to amend or
supplement the non-essential elements of the legislation (eg, EU Taxonomy).
Unanimity: only needed for changes in the Treaties, matters of political sensitivity (eg, taxation, the multi-
annual financial framework - MFF) or if the Council wants to change a Commission proposal against the
opinion of the Commission.

The European Council

It consists of the Heads of state or Government of the EU member states (ex. Olaf Scholz, Emmanuel
Macron, Giorgia Meloni, Sanna Marin...) plus the President of the EU Commission.
It meets at least two times per year, normally in December and June.
It is not one of the EU's legislating institutions, so it does not negotiate or adopt EU laws like the Council of
the EU (made of national ministers).
However, because of the principle of conferral, it is the European Council that sets the EU's policy agenda,
traditionally by adopting 'conclusions' during meetings which identify issues of concern and actions to take.
The European Council has a President, currently the former Belgium’s PM Charles Michel, elected by the
Council with qualified majority, for two years and a half (renewable once). This is different from the
Presidency of the Council of the EU.

For instance, in the conclusions of the meeting held on 15 December 2016:

“Europeans must take greater responsibility for their security. [....] The European Council welcomes the
Commission's proposals on the European Defence Action Plan as its contribution to developing European
security and defence policy, stressing the importance of fully involving Member States, and calls on all
relevant actors to take work forward. The Council is invited to rapidly examine the related Commission
proposals. [....] The Commission is also invited to make proposals in the first semester of 2017 for the
establishment of a European Defence Fund including a window on the joint development of capabilities
commonly agreed by the Member States.”

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Why? In March 2016 then GOP presidential front-runner Donald Trump questioned NATO’s relevance
(link).
In 2017, the Permanent Structured Cooperation (PESCO) was established by 25 EU members (Denmark and
Malta opted-out). PESCO aims to deepen defence cooperation to deliver the required capabilities to also
undertake the most demanding missions and thereby provide an improved security to EU citizens.

The European Parliament

Besides the Council of the EU, the European Parliament is the other decision maker of the EU.
It is the only EU institution whose members are directly elected by citizens of the member
states.
It has a single chamber with 705 members (MEPs) elected for 5 years (renewable) in common European
elections.
Each country gets a number of seats according to a “degressive proportionality principle”, i.e. per capita
deputies are lower for larger countries.
Germany has the highest number (96) of Members while Malta, Cyprus, Estonia, Luxembourg have the
lowest (6).

The European Parliament works through permanent and ad-hoc Parliamentary Committees: e.g.
environment, transport and tourism, budget etc.
The Members of the European Parliament (MEPs) sit in political groups –
they are not organised by nationality, but by political affiliation.
There are currently 7 political groups in the European Parliament. Some
Members do not belong to any political group and are known as non-
attached Members (Non-Inscrits).

The Seats of the European Parliament

Formally, European Parliament’s offices are located in three different
countries (Protocol n. 6 of the TFEU):
Administrative headquarters are in Luxembourg.
Parliamentary committees, where laws are instructed / amended, meet in Brussels for two-
three weeks every month.
However ordinary plenary sessions, where formal laws are approved, take place in Strasbourg for 3-4 days
every month, which means that deputies and staff have to move there temporarily.
Very inefficient and costly arrangement... Kind of “history joke” and certainly a good example of
compromises within the EU.

The Court of Justice of the EU (CJEU)

Ensures that national and European laws meet the terms and spirit of EU Treaties.
Ensures that EU law is equally, fairly and consistently applied in all member states.
It does so by:
- Ruling on the “constitutionality” of EU law
- Giving opinions to national courts about EU law
- Making judgments in disputes involving EU institutions, member states, individuals and corporations.
The CJEU is divided into 2 courts:
1. Court of Justice: it deals with requests for preliminary rulings from national courts,
certain actions for annulment and appeals.

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2. General Court: it rules on actions for annulment brought by individuals, companies and, in some cases,
EU governments. In practice, this means that this court deals mainly with competition law, State aid,
trade, agriculture, trade marks.

The EU law: the principles

One of the most unusual and important things about the EU is its supranational legal system. By the
standards of every other international organization in the world, the EU legal system is extremely
supranational.
Main principles:
- direct effect: EU law can create rights which EU citizens can rely upon when they go before their
domestic courts;
- primacy: Community law has the final say (e.g., highest German court can be overruled) so that it cannot
be altered by national, regional or local laws in any member state;
- autonomy: system is independent of members’ legal orders.
Nowadays on average some 70% of all the laws in place in a given Member State derive directly or
indirectly from the EU.
When it comes to business law the figure is even higher... You better get to know it!

Tools:
Treaties are the “primary” source of European Union law. They define the aims of the EU, the roles and
competencies of the EU institutions. The EU can only act within the competences granted to it through these
treaties and amendment to the treaties requires the agreement and ratification of every signatory member
according to national procedures. “Secondary” sources of EU law are:
- Regulations: the most powerful form of EU law, immediately binding for every member state.
- Directives: define mandatory goals, but the legislative actions for implementing these goals are left to the
member states (normally with a time deadline and the obligation to report to the Commission).
- Decisions: also binding, but very specific in their application, normally referring to single member states,
institutions or companies.
- Recommendations and opinions: have no binding force, usually they provide interpretations for the
application of regulations, directives and decisions.
EU is based on the principle of conferral.
EU decision-making
Decision making in the EU takes places by means of various legislative procedures that involve EU
Institutions.
The ordinary legislative procedure is the default procedure. Before the Treaty of Lisbon (2009) the
ordinary legislative procedure was named co-decision procedure.
The essential characteristic of the ordinary legislative procedure is that both the Council of Ministers as
well as the European Parliament have a deciding vote in the legislative process, and both institutions may
amend a proposal (to know more about the ordinary legislative procedure).
When the Treaties indicate otherwise, other legislative procedures are used such as the assent procedure:
this procedure is used for matters where the member states retain a larger degree of control. The word
assent refers to the role the European Parliament plays in the procedure: it has to approve or disapprove a
proposal, but cannot amend it. The last word is the one of the Council of the EU.

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The ordinary legislation

LECTURE 3: 14.02

Globalization
Elimination of tariffs, restrictions. Geography doesn’t matter anymore.
With Trump there was a change direction, since this idea of glob. couldn’t help everyone. the key fact is
competition, which means efficiency. Globalization is a world competition.

Biden administration-> favor own products. But this was

not in line with the idea of globalization.

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US vs. China Trade War

Graph 1: tariff between different countries. These are

types of protection.
Trump increase tariffs (on alluminium, steel), because American manufactures have to use these elements to
sell not only domestically, also worldwide, that’s why they need to increase competitiveness.

Theory of Economic Integration

The theory of economic integration studies how intermediate situations between pure protectionism and free
trade affect efficiency in the use of resources for every country.

Two typical arrangements are studied: Free Trade Areas (e.g. NAFTA), Customs Unions (e.g. EU).
Fundamental hypotheses: perfect competition and “small country”.
ex. Singapore is not protectionist. No tariffs.

Recall: D and S

Hypotheses

Supply of the world more efficient. It is very

cheap. Supply is flat, because we assumed that
the country we are analyzing is very small,
compared to the other countries.

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Free Trade

The big winners in this case are consumers, because

they can buy from the rest of the world, paying much
less.
There is a little room for domestic production.

In this way, we create trade (Trade creation)

How to achieve protection

Autarky - prohibitive tariff

Put a tariff on world price, so the final price of the

world production is equal to the domestic one. ->
no trade.
Foreign competition disappears and they gain.
(Trade suppression)

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Autarky vs free trade

Changes in PS and CS

From free trade to autarky - change in PS and CS

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Change in total welfare

Non-prohibitive tariff tools

We can distinguish three main tools through which protectionism can be implemented:
- Tariffs (specific or ad valorem)
- Quotas (i.e. quantitative restrictions to imports)
- Non-Tariff Barriers (NTBs), e.g. safety standards

Non-tariff barriers
- Non-Tariff Barriers are determined by the set of rules that each country imposes to regulate industrial
production methods, safety standards, environment, consumer protection, etc.
- Sanitary and phytosanitary measures refer to restrictions for substances and measures for preventing
dissemination of disease (such as certification, testing and inspection and quarantine).
- For example, the EU prohibits the placing on the market and the import of meat treated with certain
hormones and of chlorine-washed chicken.
- Another example: kinder eggs in the US
- Technical measures refer to labelling and other measures protecting the environment, standards on
technical specifications and quality requirements (e.g. to flammability or azo dyes).
- These requirements (legitimate when they aim at preserving consumers’ health) constitute a burden on
producers and build a complex layer of multiple requirements constituting additional costs (thus higher
prices).

A-A’ and B’-B are

the trade suppression
Yellow = gov. revenues

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RECAP - The “classic” theory of Economic Integration Free trade vs. Autarky

RECAP - The “classic” theory of Economic Integration Free Trade vs. Protectionism

A numerical example (NO EXAM)

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Free Trade Areas and Custom Unions

Regional Integration Agreements (RIAs)

- RIAs are groupings of countries formed with the objective of reducing barriers to trade between members
of the group
- They constitute a driving force of globalization, and are permitted by the WTO rules under article XXIV
of GATT
- EU is a prominent example of RIA
- As of January 2020, 303 RIAs are in force (see full list here)
- Almost all countries are nowadays members of a RIA, with more than 1/3 of global trade taking place
within RIAs
- Two main modes: “Free Trade Areas” vs. “Customs Unions”
Trade agreements between countries

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Two possibilities: Free Trade Area (FTA) and Custom Union (CU)

Trade deflection
- Suppose that a Free Trade Agreement (FTA) is in place between countries Home (H) and Partner (P);
- Suppose that country P autonomously decides to have free trade with country C while country H keeps its
protectionist policy vis-à-vis country C (OK in a FTA, impossible in a Customs Union).
- For example:
P is Mexico, that has a free trade agreement with the U.S. (H) and with the
European Union (C).
But there is no free trade agreement between the EU (C) and the US (H),
thus still tariffs between H and C.
If you are based in Europe (C), you can export duty-free to Mexico (P)
but it you want to export from Europe to the U.S. (H), you have to pay the tariff
What if, in order to avoid the American tariff, first you export duty-free to Mexico, and then you re-export
the same product from Mexico to the U.S.?
This phenomenon is named: (direct) trade deflection

The rules of origin to prevent trade deflection

To prevent trade deflection that shrinks country H’s - US’s - tariff revenues, the
agreement (such as the NAFTA/USMCA) writes down rules of origin to assess the
nationality of traded goods.
Rules of origin: only goods that have “origin” in the FTA (H and P) can freely
circulate between H and P. How to assess this? Only goods whose value added is
mostly created in P are said to have “origin” in P
Goods manufactured in C entering country H, directly or indirectly (via P), have to
pay TH If H and P are in a Customs Union, no need to check nationality of
imported goods, the tariff is the same in the entire CU.
If instead H and P are in a FTA, there should be custom controls to check the
origin...

The rules of origin in Free Trade Agreements

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- There is no harmonised set of rules of origin (RoO) but there are some common provisions entailed in
free trade agreements (WTO page).
- While product-specific rules of origin differ between different sectors, general rules of origin normally
apply to all sectors (video).
- There are two basic criteria for determining the origin of products:
1. Wholly obtained or produced: it applies to commodities and related products that have been
entirely grown, harvested or extracted from the soil in the territory of that member country or
have been manufactured exclusively from these products (e.g. plants, animals born and raised,
fish when caught in the territorial waters).
2. Sufficient working or processing (sufficiently transformed): for complex products there are
different criteria such as:
• Changes in tariff classification;
• Percentage of regional value content.

The Economics of Free trade Areas and Customs Unions

The Setup
Let’s consider the demand for an homogeneous good in two countries: home (H) and partner (P).
Both countries can produce the good (SH and SP)... ...or they could buy it from the rest of the world at price
pw (SW)
Notice: SP is flatter than SH : for all prices, P can supply more units of the good than H (= P is more efficient
than H in producing the good)

We will analyze the consequences of the creation of a FTA or a CU between H and P under different
circumstances

FTAs - Four cases to be considered

Case 1
- Let’s consider two countries: home (H) and partner (P)
- Prohibitive tariff TH in H: OHQH is
domestically produced and consumed, no
imports from RoW
- Prohibitive tariff TP in P; OPQP is domestically
produced and consumed, with no imports from
RoW

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Then:
A Free Trade Area is formed: goods can freely circulate between H and P
• Each country maintains autonomous trade policies with RoW (tH tP) → rules of origin ensure that
only products originated or mainly produced in the area are entitled to be freely exchanged.
• H has access to P’s production: we can draw the supply SH+P...
• ...and the effective supply under the FTA (SH,FTA), which takes into account that P can supply up to
OPQP at the price pFTA = pP
• At the price pFTA = pP country H’s demand of imports from country P is represented by the quantity CD
• P exports EQP =CD. It satisfies its demand OPQP by producing domestically OPE and importing EQP
from the rest of the world (indirect trade deflection) at price pw (consumers pay the after- tariff price Tp)
• NOTICE: P is “large enough” to be able to satisfy H’s demand of imports at the price pFTA = pP

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Case 2
- Let’s consider two countries: home (H) and partner (P).
- Prohibitive tariff TH in H; OHQH is domestically produced and consumed , with no imports from RoW.
- Prohibitive tariff TP in P; OPQP is domestically produced and consumed, with no imports from RoW.
- P is not “large enough” (more on this in the next slide)

Then:
- A Free Trade Area is formed: goods can freely circulate between H and P
- Each country maintains autonomous trade policies with RoW (tH tP) → rules of origin ensure that
only products originated or mainly produced in the area are entitled to be freely exchanged
- H has access to P’s production: we can draw the supply SH+P...
- ...and the effective supply under the FTA (SHFTA), which takes into account that P can supply only up to
OPQP at the price pP
- Notice: pFTA > pP because country H’s demand of imports from country P at price pP can’t be satisfied
(P is not “large enough)!
- At pFTA , H’s demand for imports is represented by the quantity CD
- P exports OPE =CD. It satisfies its demand OPQP by importing OPQP from RoW (indirect trade
deflection) at price pw (consumers pay the after-tariff price Tp)

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Welfare analysis:
- H gains from the FTA in that its consumers can now buy the good at price pFTA<pH => trade creation
(1) + (2)
- H does not experience trade diversion (which happens when a country changes trade partner) → the
effect on H is unambiguously positive: (1) + (2)
- satisfies its demand OPQP by importing OPQP from the rest of the world (max indirect trade
P
deflection); the Government gains the revenue on the imported goods (4)
- Producers export OPE to Home: ΔPS = 5
→ the effect for P is unambiguously positive (4 + 5)
Note that we observe price discrimination: price pP in P and price pFTA in H

Case 3
- Let’s consider two countries: home (H) and partner (P)
- Less than prohibitive tariff TH in H; OHA is domestically produced and OHB demanded, AB is imported
from RoW
- Prohibitive tariff TP in P; OPQP is domestically produced and sold, with no imports from RoW

Then:
- A Free Trade Area is formed: goods can freely circulate between H and P
- Each country maintains autonomous trade policies with RoW (tH tP) → rules of origin ensure that
only products originated or mainly produced in the area are entitled to be freely exchanged
- H has access to P’s production: we can draw the supply SH+P...
- ...and the effective supply under the FTA (SHFTA), which takes into account that P can supply up to
OPQP at the price pFTA = pP
- At the price pFTA = pP country H’s demand of imports from country P is represented by the
quantity CD. NOTICE: H was importing from RoW and is now importing from P, because it
is cheaper! (trade diversion)
- P exports EQP =CD. It satisfies its demand OPQP by producing domestically OPE and
importing EQP from RoW (indirect trade deflection) at price p (consumers pay the after- tariff price
w
Tp)

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Welfare analysis:
- H gains from the FTA in that its consumers can now buy the good at price pFTA<pH => trade creation
(1) + (2)
- H experiences trade diversion (3): H substitutes imports AB at price pw with the same quantity at price p
>p , hence experimenting a loss (note that the government loss in tariff FTA w revenues - area pwTH*AB
- is partly compensated by consumer surplus) → the effect on H is ambiguous: (1) + (2) – (3)
- satisfies its demand OQP producing domestically OPQP and importing EQP from the rest of the world
P
(indirect trade deflection); the Government gains the revenue on the imported goods (4)

Case 4
- Let’s consider two countries: home (H) and partner (P)
- Less than prohibitive tariff TH in H; OHA is domestically produced and OHB demanded, AB is imported
from RoW
- Prohibitive tariff TP in P; OPQP is domestically produced and sold, with no imports from RoW • P is not
“large enough” (more on this in the next slide)

Then:
- A Free Trade Area is formed: goods can freely circulate between H and P.
- Each country maintains autonomous trade policies with RoW (tH tP) → Rules of origin
ensure that only products originated or mainly produced in the area are entitled to be freely
exchanged.
- H has access to P’s production: we can draw the supply SH+P...
- ...and the effective supply under the FTA (SHFTA), which takes into account that P can supply only up to
OPQP at the price pP
- Notice: pFTA > pP because country H’s demand of imports from country P at price pP can’t be
satisfied (P is not “large enough”)!
- At pFTA , H’s demand for imports is represented by the quantity CD
- P exports OPE =CD. It satisfies its demand OPQP by importing OPQP from RoW (indirect
trade deflection) at price pw (consumers pay the after-tariff price Tp)
- H was importing from RoW and is now importing from P, because it is cheaper! (trade
diversion)

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Welfare analysis:
- H gains from the FTA in that its consumers can now buy the good at price pFTA<TH => trade creation
(1) + (2)
- experiences trade diversion (3): H substitutes imports AB at price pw with the same quantity at price p
H
>p , hence experimenting a loss (note that the government loss in tariff FTA w revenues - area pwTH*AB
- is partly compensated by consumer surplus) → the effect on H is ambiguous: (1) + (2) + (3)
- P satisfies its demand OPQP by importing OPQP from the rest of the world (max indirect trade
deflection); the Government gains the revenue on the imported goods (4)
- Producers export OPE to Home: ΔPS = 5. → the effect for P is unambiguously positive (4 + 5)
Note that we observe price discrimination: price pP in P and price pFTA in H

The economics of Customs Unions

CUs . Intro
In CUs, participating countries, apart from abolishing all trade restrictions among themselves, also relinquish
their ability of independently fix their tariffs towards the rest of the world in favor of a Common External
Tariff (CET)
→ the CET will be fixed at a level convenient for each member of the CU
Once the CET is established, P cannot freely supply its production to H because it cannot import from the
RoW at its own tariff, only at the CET
→P will only be willing to export to H its excess supply (which is positive as long as CET > PP)

Case 1
- Let’s consider two countries: home (H) and partner (P)
- Prohibitive tariff TH in H: OHQH is domestically produced and
consumed, no imports from RoW
- Prohibitive tariff TP in P; OPQP is domestically produced and consumed, with no imports from RoW

Then:
- A customs unions is formed: goods can freely
circulate between H and P
- The trade policies of countries are common: a
Common External Tariff (CET) is adopted w.r.t.
imports from RoW, such that TH < CET < TP
(tariff averaging). No indirect trade deflection,
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so no need of rules of origin. An agreement ensures the apportionment of customs revenues to each
country
- We consider a CET ensuring autarky of the integrated area (more on this in the next slide).
- H has access to P’s excess demand MP (P cannot import from RoW at pw as in the FTAs, but it can
import only at CET), so we can draw the supply SH+ MP ...

- ...and the effective supply under the CU (SH ), which takes into account that P can supply up to its
CU
excess of supply at all prices above pP
- The equilibrium free-trade price between H and P is exactly @ the CET. Country H’s demand of
imports from country P is represented by the quantity CD.
- P exports to H only its excess supply FE=CD. P satisfies its domestic demand OPF by producing such
quantity domestically.

Notice
- We decided to set the CET exactly at the equilibrium free-trade price between members, for simplicity.
- CET could be above it and nothing would change in our graph in terms of imports and exports.
- CET could be below it...what would happen then?
- Part of H’s demand for imports would be satisfied by the RoW, i.e. H would be importing from both P
(CD = FE, with no tariffs) and RoW (DE, subject to a tariff).
- So, the CET we have chosen in the previous one is the minimum one ensuring autarky of the integrated
area.

Welfare Analysis

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Case 2
- Let’s consider two countries: home (H) and partner (P)
- Non prohibitive tariff TH in H: OHA is domestically produced, OHB is domestically consumed and AB is
imported from RoW
- Prohibitive tariff TP in P; OPQP is domestically produced and consumed, with no imports from RoW

Then:
- A customs unions is formed: goods can freely circulate between H and P
- The trade policies of countries are common: a Common External Tariff (CET) is adopted w.r.t. imports
from RoW, such that TH < CET < TP (tariff averaging)
- H has access to P’s excess demand MP (P cannot import from RoW at pw as in the FTAs, but it can
H
import only at CET), so we can draw the supply S + MP …

- ...and the effective supply under the CU (SHCU), which takes into account that P can supply up to its
excess of supply at all prices above pP
- At the price CET, country H’s demand of imports from country P is represented by the quantity CD. H
experiences trade diversion: now, it imports from P (before, the partner was RoW)
- P exports to H only its excess supply FE=CD. P satisfies its domestic demand OPF by producing such
quantity domestically

Welfare Analysis:

Free Trade Areas

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vs. customs Unions (compare case FTA3 to CU2)

Discussion:
FTAs vs. CU: Which one to choose?
- NAFTA (North American Free Trade Area, i.e. US, Canada, Mexico) is shaped as a FTA. In fact, Mexico
and Canada are allowed to have a FTA with the European Union, with rules of origin protecting NAFTA
from EU exports.
- The European Union is shaped as a Customs Union (since 1969, after its creation in the 1957 Treaty of
Rome)
- The EU-Turkey trade relations are shaped as a Customs Union since year 1995
- The EU-Korea trade relations are shaped as a FTA as of 2014
- We have shown that under standard assumptions FTAs are more efficient than Customs Unions
- Why the EU founding countries have chosen to create a Customs Union ?
- Why the US have chosen to create a FTA with Mexico and Canada? Why the EU has opted for a FTA
rather than a
CU with Korea?
From a transaction-costs perspective:
1. Customs Unions however imply a political cost of negotiations, which grows with the size and
heterogeneity of
the CU, thus generating a trade-off with different optimal solutions depending on the specific case
2. Customs unions can generate greater welfare effects for member countries by increasing their bargaining
power on the global stage (i.e. removal of the “small country” hypothesis), leading to favourable trade
agreements.

Benefits of CU
- Why did the EU choose to be a Customs Union and not a Free Trade Area?
- One of the reasons is that with an FTA the EU would remain a union of "small" countries with
independent tariffs and independent trade policies. . A CU allows them to play as one single player at the
table of international trade negotiations (eg the WTO). In this position the EU would get more bargaining
power if it is a CU than a FTA. If it is a CU it can threaten the rest of the world to raise CET credibly.
Why this should be credible?
- Because, as a CU, the EU becomes a "large country" and might gain by charging a moderate tariff
unilaterally. This gain makes the threat credible. At the bargaining table for tariff reductions, a credible
threat would lead third countries to reduce their tariffs too.

Economies of Scale in Customs Unions

- Let’s consider two countries: home (H) and partner (P)

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- A homogeneous good is produced in the two countries H and P at declining average costs (AC curve),
with P more efficient than H (ACP is always lower than ACH) => e.g. steel; or a differentiated good =>
cars
- Because of the shape of supply (cost) curves, the minimal tariff that can be sustained at equilibrium is the
prohibitive one (no imports from RoW). Hence country H internally produces and consumes O A at price
T , while country P internally produces and consumes O Q at price T . HH PP

Then:
- A customs unions is formed: goods can freely circulate between H and P
- The trade policies of countries are common: a Common External Tariff (CET) is adopted w.r. to imports
from RoW. An agreement ensures the apportionment of customs revenues to each country
- When the CU is formed, the most efficient producer (P) attracts all the demand of country H => DP+DH
- At the price CET, H imports the quantity OHA’ from P, which consumes the quantity OPQ’ and produces
the quantity OPX

Welfare effects:
- H gains from the CU since its consumers can now buy the good at price CET<TH => trade creation (1)
+ (2)
- At CET, consumers in P demand OPQ’>OPQ at a lower price, hence experiencing the cost reduction (3)
+ (4), while producers produce OPX>OPQ, hence the country also gains in terms of employment (it
produces more→more workers needed)
- Notice: we cannot compute Producer Surplus (PS) as the relevant curve depicted here is the AC, not the
MC!

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Economies of Scale in CU: some practical caveats

- If country H is not producing the good before the CU but only importing from RoW at p , W then the
CET will imply a negative trade diversion to a more expensive source of imports (country P).
- If instead country P is not producing the good before the CU, there will be a production reversal from H
to P. Consumers in H will benefit from trade creation, but those in P will suffer from “trade suppression”,
as cheap imports from RoW are replaced by less efficient internal production.
- We might observe “perverse specialization” if a large, though less efficient, captures the whole market
just due to a market-size advantage...
.... do we need a social planner then? Would she/he be able to identify the most efficient producers?

Trade diversion
Initially, country H is not producing the good (TH is not prohibitive) but it is importing from RoW at pW;
Country P is producing the good (TP is prohibitive).
Then, with a CU:
- consumers in H consume OB;
- consumers in P consume OC;
- P exports CD=OB to H.

Trade diversion - welfare effects

- Country H was importing from RoW at p , then with a CU: consumers gain 1+2, the Government W loses
1+3→net effect is 2 – 3
- Net/trade effects: a negative trade diversion (3) due to a more expensive source of imports
(country P), but still a positive trade creation (2 consumption effect)
- In country P, a cost reduction (4+5) → consumers in P can consume more at a lower price, because of the
lower production cost (recall: economies of scale)

Trade suppression
Initially, country H is producing the good (TH is prohibitive); Country P is not producing the good and is
importing OQ from the RoW at Pw (TP is zero).
With the CU
- Consumers in H will consume OB (imports
from P);
- Consumers in P will consume OC
- P exports CD = OB to H

Welfare effects:
- Country H was producing the good (TH is
prohibitive); Country P was not producing the
good and was importing OQ from the RoW at
Pw + tariff = TP.
- With the CU, Consumers in H gain 1+2;
Consumers in P gain 4+5, the Government loses
4+6 → net welfare effect is 5 - 6.
- Net/trade effect: in H, trade creation (1+2); in P
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trade creation (5, consumption effect) and “trade suppression” (6), as cheap imports from RoW are
replaced by less efficient internal production.

Perverse specialization
- We might observe “perverse specialization” if a large, though less efficient, captures the whole market
just due to a market-size advantage.
- Assume that country H is less efficient but larger than Country P (see AC and D)
- If consumers prefer to buy the cheapest good, then consumers in Partner will buy in Home (TH < TP): the
producer in Partner stops its activity.
- The additional production in Home slightly reduces the ACH. The beneficial effects in Home and Partner
could be larger if P were the only producer.

- Differently from other cases, the starting price (TH and TP) is not properly signalling the efficiency level
of the producer.

From Customs Unions to the Common Market

- In a model of Customs Unions with economies of scale, net effects are overall positive but we “ignore”
the loss of surplus accruing to producers in H.
- We suppose in fact that producers in H will shift their production processes to another good in which H
has a comparative advantage (the analysis here considers only one good at the time)
- Alternatively, we can suppose that producers in H can move their production in P => then rules have to be
written for allowing a movement of factors of production (labour and capital)
=> a Common Market, with 4 fundamental freedoms, “naturally” follows a Customs Union where
economies of scale are relevant

LECTURE: 28.02 - EU TRADE POLICY

EU trade policy and its single market

With the Treaty of Rome (signed in 1957 and entered into force in 1958), the EU member States decided:
- to start the process of forming a common/single market by abolishing legal restrictions to trade within the
EU.
- To set up a Customs Union, I.e. a unique EU trade policy vis-à-vis the rest of the world with the aim to
liberalize trade (see for ex. EU involvement in the WTO and trade bilateral agreements).
The EU adopts a consistent approach for the internal and the external dimension, ie, inside and outside the
single market: free and fair trade.
EU trade policy: goals and tools
- the EU is the world’s biggest trader
- Open trade among EU countries (i.e. the common market) is the cornerstone of
the EU and has brought prosperity to all its member states.
- The EU believes that increased trade (and competition) is likely to boost world
growth to everybody’s advantage.
- Globalisation can bring economic benefits to all, including the developing countries, provided
appropriate rules are adopted at the multilateral level and efforts are made to integrate developing
countries in world trade.
- That is why the EU:
- Is a member of the world trade organization (WTO)
- Negotiates and signs (bilateral/regional) trade agreements with third countries

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- EU Trade Policy has always been one of the most effective foreign policy tools.
- The Lisbon Treaty considers explicitly trade policy as an integral part of the EU
external action. In particular, Article 3 par. 5 of the TEU states: ‘In its
relations with the wider world, the Union shall uphold and promote its values and interests and contribute
to the protection of its citizens. It shall contribute to peace, security, the sustainable development of the
Earth, solidarity and mutual respect among peoples, free and fair trade, eradication of poverty and the
protection of human rights, in particular the rights of the child, as well as to the strict observance and
development of international law, including respect for the principles of the United Nations Charters.’

EU institutions for trade policy

- The customs union was the EU’s first big step towards economic integration.
- A customs union requires political coordination as it defines the external dimension of the Union.
- The Treaty of Rome granted supranational powers to the EU’s institutions: ‘exclusive competence’, ie,
the EU has exclusive power to set the trade policy with third nations (individual Member States
cannot sign independent trade agreements - only business to business).
- In the twentieth century, the EU’s power on trade policy was basically limited to tariffs. As the range of
important trade barriers broadened, the competence of the EU has been extended (eg, to foreign
investment, services, property rights): big step forward with the Lisbon Treaty (2009).
- The European Commission has the task of negotiating trade matters with third nations on behalf of the
Member States. The Commission has also the right of initiative on trade agreements and it supervises the
implementation of such agreements.
- The European Parliament is co-legislator with the Council on all basic EU trade legislation (eg,
granting GSP preferences, imposing anti-dumping measures).
- Negotiations are conducted by the Commission in accordance with specific mandates defined by the
Council and the Parliament. Such directives are approved through ‘ordinary legislative procedure’.
- The Council must adopt any agreements negotiated by the Commission after the Parliament has given its
consent. Parliament cannot amend in this case (but has influence through veto power).
In the U.S.: Trade Promotion Authority (TPA), also called "fast track“, gives the President the power to
negotiate trade agreements, draft implementing legislation to change US law, and sign agreements into
international law. Congress’s involvement is restricted to an up or down vote on the final bill with no
amendments allowed.

EU’s Competence
The EU's exclusive competence covers the following matters:
- trade in goods, including regulatory matters;
- trade in services, including mutual recognition agreements and all transport services;
- trade related aspects of Intellectual Property (IP);
- public procurement ex. Building an hospital;
- market access in the area of FDI;
- investment protection as far as it concerns FDI;
- trade and sustainable development in its entirety; and
- the termination of member State bilateral investment agreements for the parts concerning exclusive
competence.
When agreements cover policy areas that are not only of EU’s exclusive competence are named ‘mixed’ and,
along with the EU approval, national parliaments (36 chambers) have to ratify them. For example, in the EU-
Singapore FTA the ECJ found that portfolio investments and the investor-State dispute settlement (ISDS)
procedures were not exclusive competence of the EU.

EU institutions for trade policy: national governments

- Financial Times (11 November 2021). France has persuaded the EU to postpone signing two new trade
agreements until after its presidential elections in April 2022, angering other member states which want
the deals to be concluded.
- The EU had hoped to finalize trade pacts with Chile and New Zealand in 2022 but Paris convinced the
European Commission to delay the deals.
- EU diplomats said Emmanuel Macron, president of France, feared a surge in imports of chicken from
Chile and lamb from New Zealand, which opposition candidates could use to mobilize farmers and
groups opposed to globalization as he campaigns for re-election. p.s. The deal with Chile would give the
EU easier access to secure supplies of lithium to boost its electric car industry and reduce dependence on
China.

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The objectives of the WTO

• The World Trade Organization (WTO) is an international organization that is concerned with the
regulation of trade between nations.
• The WTO commenced in 1995 and replaced the General Agreement on Tariffs and Trade (GATT).
The objectives of the WTO are:
• That international economic relations should be conducted with a view to raising standards of living,
ensuring full employment and a large and steadily growing volume of real income and effective
demand;
• Expanding the trade in goods and services; and
• While allowing for the optimal use of the world’s resources in accordance with the objectives of
sustainable development, seeking both to preserve the environment and to enhance the means of doing
so in a manner consistent with their respective needs and concerns at different levels of economic
development.

The WTO in practice

1) The WTO as a negotiating forum.
• WTO members (countries) negotiate and adopt agreements with the aim to promote free and fair trade.
164 countries are in the WTO; the observers: Algeria, Belarus, Ethiopia, Iran, Serbia, Somalia, Sudan...;
not even observers: North Korea, Eritrea ...
• WTO’s scope is not limited to tariffs reduction but also to trade-related issues (eg, services, standards,
labour, competition, IPRs).
• Agreements can be multilateral (all WTO members) and plurilateral (some WTO members).
• The bulk of the WTO's current work comes from the 1986-94 negotiations called the
Uruguay Round and earlier negotiations under the GATT.
• WTO members launched a new round of negotiations in 2001 “Doha Development Agenda”
(after Seattle 1999); still ongoing, but its future is uncertain.
2. The WTO as a resolution mechanism for trade disputes that arise, for example, when a member
government believes another member government is violating an agreement or a commitment that it has
made in the WTO. (Dumping: lowering the price of exports in order to increase market share)

The principles of the WTO

1) Reciprocity. WTO members have symmetric rights and obligations, and could obtain mutually
beneficial reductions of trade barriers.
2) Consensus. In the WTO nothing gets decided unless there is ‘consensus’: if no Member, present at the
meeting when the decision is taken, formally objects. 164 members, but they often negotiate in
coalitions (e.g. agricultural exporting countries such as the Cairns group).
3) Single undertaking. Every item of the negotiation is part of a whole and indivisible package and cannot
be agreed separately. i.e. Nothing is agreed until everything is agreed.
4) Non-discrimination. Once foreign products enter into an importing country, they should be accorded a
treatment equal to the one guaranteed to similar national products (National treatment); all WTO
members should receive by another member the same treatment as the one accorded to the partner
country that receives the best treatment (Most favoured nation, MFN).
5) Tariff bindings. Once a tariff reduction has been negotiated and accepted, it becomes “bound” at the
negotiated rate.

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The MFN treatment

Some caveats
- Countries enter the WTO with their own tariff profiles and they can keep tariffs once member; tariff
elimination is a long-term aim of the WTO members.
- MFN tariffs are what countries promise to impose on imports from other members of the WTO, unless the
country is part of a preferential trade agreement (such as an FTA). Thus, MFN tariffs are the highest
that WTO members charge, by default, one another.
- The tariffs that country A adopts against import from country B is, in majority of cases, different from the
tariffs country B adopt against import. Reciprocity has more a ‘dynamic’ understanding (thus about the
change) rather than the absolute value of respective tariffs.

MFN: bound vs. applied tariff

- When countries join the WTO, or when WTO members negotiate tariffs with each other during trade
rounds, it is about MFN bound tariffs.
- The bound tariff is the maximum MFN tariff level for a given product.
- However, bound tariffs are not necessarily the rate that a WTO member applies in
practice to other WTO members' products.
- Members have the flexibility to increase or decrease their tariffs (on a non- discriminatory basis) as long
as they don't raise them above their bound levels (this is the MFN applied tariff).
- If one WTO member raises applied tariffs above their bound level, other WTO members can take the
country to dispute settlement.

EU tariffs, bilateral agreements and the GSP

The tariff structure of the EU

- When declared to customs in the EU, goods are classified according to the Combined Nomenclature
(CN). This determines which rate of customs duty (tariff) applies and how the goods are treated for
statistical purposes.
- The CN is based on an international classification of products known as the Harmonized System
Nomenclature (HS): it comprises about 5,000 commodity groups which are identified by a 6-digit code

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and arranged according to a legal and logical structure based on fixed rules common to all countries in the
world.
- The tariff structure of the EU (TARIC database) indicates the tariff for every single detailed product
classified in the HS nomenclature (eg. “men’s cotton shirts” - 610510, are different from “women’s cotton
shirts” – 610610, or from “men’s artificial fibers shirts” - 610520 , etc.)
- Some products have relatively high tariffs amidst generally low tariff levels, known as tariff ‘peaks’, i.e.
an ad valorem tariff > 15% (e.g. sports footwear – 640411).

EU bilateral agreements
- The EU (as other countries) negotiates its own bilateral trade agreements with countries or regional
groups of countries.
- Ifa country negotiates agreements with other countries, that means that the tariffs that both parties are
committed to set are below the MFN tariff (the default tariff set for WTO members), this is why they are
also named preferential trade agreements (PTAs).
For example EU signed FTA agreements with, among others: Balkan States
(e.g. Albania, Serbia) and other European States (Norway, Iceland and
Switzerland), Mexico (2000), South Africa (2000), Chile (2003), Korea
(2010), Colombia and Peru (2012), Canada (2016), Japan (2018),
Singapore (2019); and CU agreements with Andorra (1991), San Marino
(1992) and Turkey (1995).
- Recently the EU is signing Deep and Comprehensive FTAs involving
FDI, services, protection of intellectual property rights etc.

The EU’s ‘Pyramid of preferences’

The pyramid of preferences ranks the preferential

relationships of the EU with the various countries
in the world according to a decreasing degree of
preference.
The top of the pyramid expresses the maximum
preferential treatment that the EU can grant to
another country, i.e. the membership of the EU.
At the bottom of the pyramid: the MFN tariff (i.e.
the default CET) applied by the EU when no
specific preferences are granted but the ones
agreed within the WTO rules.

Fair trade: EU’s GSP

The WTO tariff is the default tariff (the MFN, also known as ‘erga omnes’). This tariff is reduced in case of
free trade agreements. FTA are symmetrical.
The WTO allows to violate the MFN rule to give a special and differential treatment to developing countries
(see EU, US). In the EU:

The ‘Generalized Scheme of Preferences’ is a unilateral reduced MFN tariffs for a list of developing
countries. This applies to e.g. Indonesia, India, Kenya, Vietnam.
The “GSP+” enhanced preferences implies deep cuts or full removal of tariffs for the same product
categories as in standard GSP. This can be granted to countries which implement international
agreements on human rights, labor rules, environmental issues and good governance. This applies to
e.g. Bolivia, Mongolia, Pakistan, Philippines, Sri Lanka. The ‘Everything but Arms’ initiative is a
special exemption granting to the least developed countries (LDCs) a zero-tariff access to the EU for
all their products but arms. This applies to e.g. Bangladesh, Eritrea, Ethiopia, Gambia, Haiti, Nepal,
Senegal.

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EU Bilateral agreements
2 main dimensions:
1. the neighbourhood dimension, or “proximity policy”, which
concerns the countries close to Europe, and aims at
strengthening the EU trade and political relations with the
“ring of friends” i.e. countries surrounding the EU from
Ukraine to Morocco. => Mostly via Association
Agreements
2. the enhanced EU sphere of influence as a global partner
promoting peace, security, development etc.
=> Mostly via Cooperation Agreements, although less and less so
lately
Both cooperation and association agreements involve free trade and cooperation, but Association
Agreements pursue wider and deeper initiatives on different policy areas (e.g. respect of human rights and
democratic principles). In certain cases, they prepare for future membership of the EU by containing an
‘accession clause’.

EU Agreements
- So far we have depicted a “hub-and-
spoke” system: the EU is the hub for a number of trade deals. Exporters in partner countries depend
heavily on the EU as an export market, while each partner is negligible for the EU as a whole.
- Turkey adopts the EU CET, so it is essentially in customs union with the EU (except for agricultural
goods), although it has no say in the determination of the CET.
- EFTA nations have been following the EU in signing similar FTAs (e.g. with the Med countries), and
Turkey is doing the same lately.

Balkans: the EU has granted preferential trade

access on asymmetric basis over time. In particular,
several “Stabilization and Association
Agreements” have been signed, involving
cooperation in view of future membership of the
Union, as for Croatia. Albania, North Macedonia,
Montenegro and Serbia are already candidates.

- Several Partnership and Cooperation Agreements

are in place with CIS countries, e.g. Moldova.
- Association Agreement ratified with Ukraine
(2014)

EU trade policy with former colonies

- Colonial ties almost always involved important trade relations. To avoid imposing the CET on imports
from former colonies, starting from the Sixties, the EU (then EEC-6) signed agreements with many of
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them: asymmetric deals where EU tariffs were set to zero (at least on industrial goods) but the poor
nations did not remove theirs.
- These agreements have been renegotiated various times and in 2000 the EU and the ACP (African,
Caribbean, Pacific) nations agreed to modernize the deal (also because it was inconsistent with the WTO
as it distinguished among developing nations on the basis of colonial ties).
- With the Cotonou Agreement, ACP nations commit to eventually removing their tariffs against EU
exports by negotiating bilateral Economic Partnership Agreements (EPAs) with the EU and among
themselves.
- Underlying idea: opening up to competition is essential for fostering development, besides simple
preferential access to EU markets.

EU as Global Partner: non-regional FTAs

The EU is always open to Deep and Comprehensive FTAs involving FDI, services, protection of intellectual
property rights etc.
In recent years, the EU has signed a number of these deals (via cooperation or association agreements), e.g.
Mexico, Chile, South Africa, South Korea, Japan. FTA with Canada (CETA) under ratification.
Current focus: Work on FTAs with Australia, Philippines and Indonesia... Asia-Pacific region identified as
crucial.

EU-Korea FT
- Korea was designated a priority FTA partner for the EU in its trade policy strategy and negotiations were
launched in 2007. The Agreement has been provisionally applied since July 2011 and is fully operational
since 2014.
- The EU-Korea FTA is the most comprehensive free trade agreement ever negotiated by the EU:
- Import duties are to be eliminated on nearly all products; 98.7% of duties in terms of trade value will be
eliminated within five years (for a limited number of highly sensitive agricultural and fisheries products
the transitional periods will be longer than seven years).

- There is far reaching liberalisation of trade in services including in telecommunications, environmental

services, shipping, financial and legal services.
- Specific rules on a common jurisdiction for the protection of foreign direct investments have also been
negotiated.

Different interests within the EU

Fiat-Chrysler Group CEO Sergio Marchionne called on the EU to
change the direction of trade negotiations and to help strengthen
domestic producers.
Marchionne opposed the free trade agreement between Europe and
Korea

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EU Exports to and Imports from Korea

The effects of the FTA

WTO and trade remedy measures

- Free trade is, in principle, beneficial: it improves efficiency, reduces costs and prices, and boosts
innovation.
- However, this competition should favour the best suppliers that compete ‘fairly’, thus avoiding:
- Dumping: when a firm exports a product to another WTO member at a price that is lower than the
normal value of the product (the domestic prices of the same product or the cost of production + a
reasonable profit) and the domestic industry of the importing country is (or risks to be) seriously
injured.
- Subsidies: when a government or any public body of a WTO member confers a financial benefit to a
firm or a group of firms. Subsidies are frequently used to promote legitimate objectives (e.g. social
policies). However, they may also have adverse effects giving a favourable treatment to specific firms
that other firms in the same market (domestic or foreign) do not get. (See State aid rules in the EU in
Competition Policy slide set)
- Putting national security of importing country at risk.
Fair trade: restoring the right price
What happen if a WTO member (country) is negatively affected by an alleged dumping or subsidisation? It
can adopt:
- Anti-dumping duties: a temporary increase of the tariff to fill the gap caused by the dumping (i.e. the
difference between the normal value and the export price of the product at issue).
- Countervailing duties: a temporary increase of tariff(s) to counteract the injurious effects of subsidised
imports and restore fair competition. The level of an anti-subsidy duty should thus correspond to the
difference between a subsidised export price and a non-subsidised export price.

A case of anti-dumping:
Leather shoes from East Asia to Europe
- 30 May 2005. The European Commission received a complaint lodged on by the European
Confederation of the Footwear Industry on behalf of producers representing more than 40% of the total
EU production of certain footwear with uppers of leather.
- The product allegedly being dumped is footwear “with uppers of leather or composition leather other
than: footwear which is designed for a sporting activity and has, or has provision for the attachment of,
spikes, sprigs, stops, clips, bars or the like, skating boots, ski-boots and cross-country ski footwear,
snowboard boots, wrestling boots, boxing boots and cycling shoes, slippers and other indoor footwear,
and footwear with a protective toecap” originating in the China and Vietnam.

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EU’s import of footwear with uppers of leather or composition later (ton)

Employees in footwear manufacturing (full-time equivalent)

The investigation and the anti-dumping duties

According to the European Commission's investigation (undertaken in factories jointly agreed with the
Vietnamese and Chinese governments):
There is dumping flowing from evident state intervention (cheap finance, tax holidays, non-market land
rents, improper asset valuation).

The Commission concluded that there is clear evidence of injury to EU producers.

Since 2001, closely tracking the rise in dumped imports, European footwear production has contracted by
about 30%.
February 2006. Provisional duties: 19.4% for China and 16.8% for Vietnam.
October 2006. Definitive duties: 16.5% for China and 10% for Vietnam.
December 2009. A 15-month extension of duties (instead of 5 years, the maximum allowed).

Subsidies: Boeing and Airbus

Since 2004 there is a dispute between the US and the EU over subsidies to respective airplane makers:
Boeing and Airbus.
1. US against EU: Airbus received unfair subsidies via government loans (from France, Germany, Spain
and Britain) for the A350 jetliner and the A380 superjumbo.
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2. EU against US: Boeing received support from the US government, NASA and various states and
municipalities; in particular for the twin-engined 777X Boeing got a tax break of 8.7 billion USD from
Washington state. S
For the first case, the WTO confirmed that Airbus received illegal subsidies and authorized the U.S. to
increase its tariffs on goods imported from the EU up to 7.5bn USD (14 Oct 2019).
For the second case, the WTO confirmed that Boeing received illegal subsidies and authorized the EU to
increase its tariffs on goods imported from the U.S. up to 4bn USD (26 Oct 2020).

The national security exception

- In the GATT (Art. XXI): nothing in the agreement shall prevent a government from “taking any action
which it considers necessary for the protection of its essential security interests.” However, those
“interests” are not defined by the GATT.
- For almost seven decades, first GATT Contracting Parties and later WTO Members commonly regarded
Art. XXI as a Pandora’s box that was best kept closed, due to the high potential for abuse of this provision
as for some countries, every country must be the judge in the last resort on questions relating to its own
security.
- A totally self-judging provision means that any Member could unilaterally suspend its WTO obligations
by invoking this provision, leaving the affected Members unprotected.
- The danger is indeed that national security exceptions can be used by countries to give themselves ‘carte
blanche’ freedom to flout their obligations under the WTO agreements.

Steel and aluminium: a case of national security in the U.S.

- US is imposing tariffs on foreign steel (25%) and aluminium (10%) justifying them on national security
grounds.
- US President argued that global oversupply of steel and aluminium, driven mainly by China, threatens
American steel and aluminium producers, which are vital to the US
- What about US trade partners’ reactions? China, Canada, Mexico and the EU adopted retaliatory
measures; for example EU’s reaction and Harley-Davidson’s reduction of manufacturing in the U.S.).
- In June 2018 the EU requested consultations with the U.S. and in October 2018 the establishment of a
panel (case DS548).
- The U.S.: “there is no basis for a WTO panel to review the claims of breach raised by the EU. Nor is
there any basis for a WTO panel to review the invocation of Article XXI by the U.S. We therefore do not
see any reason for this matter to proceed further. ... it is simply not the role of the WTO to review a
sovereign nation's judgment of its essential security interests”.
- By raising domestic prices the tariffs distorted incentives. The extra cash, combined with an
apparent rise in demand, induced steel companies to splash out on new capacity.
- Domestic demand? Some American manufacturers have delayed steel-heavy projects or
switched to alternative materials.
- Extra supply, where to? Overseas, America’s high-cost producers cannot compete with cheap
alloys from places like China.
- Joe Biden’s commerce secretary has warned that protecting U.S. steel is a matter of national
security, adopting predecessor Donald Trump’s position.
- Favouring an input industry means disadvantaging downstream customers. Manufacturers such
as General Motors have complained about prices and shortages for semiconductors and raw
materials such as steel. But, so far, makers have passed on costs to their end-consumers.
Steel: the truce between the US and EU
31 October 2021. During the G20 meetings in Rome and on the eve of the Glasgow COP26 conference, the
EU and U.S. announced that they had reached a deal over their dispute on steel and aluminum (Bruegel
post):
- The US will remove tariffs on a quota of 4.4 million tons; tariffs remain beyond that quota.
- Suspension of EU retaliatory tariffs of up to 50% on items such as steel products, bourbon, motorcycles,
jeans etc.
- Suspension of scheduled additional EU retaliatory tariffs on $4.2 billion US exports planned for 1
December 2021.
- Withdrawal of WTO cases on both sides. (On 4 November 2021 the EU requested a suspension of the
panel)
- A joint statement on the intention to negotiate some form of carbon content standard on steel imports,
and at the same time deal with overcapacity, including a specific mention of China.

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Bilateral agreements violate the WTO’s MFN principle!

- EU and NZ are members of the WTO. In clothing, for example, NZ applies a 9.7% MFN tariff, the EU
11.5%.
- NZ and the EU are negotiating a Free trade agreement (FTA) to eliminate bilateral tariffs, also on clothing.
- According to the MFN principle, as soon as the FTA enters into force, that tariff elimination should be
extended to all other WTO members (a zero tariff is the best treatment possible).
- If NZ and the EU do not extend this treatment to other WTO members, yes, it is a violation of the
principle of non-discrimination.
- But the WTO allows those preferential bilateral agreements as an exception to the MFN principle if two
conditions are fulfilled:
1st: Tariffs and other trade barriers should be reduced or removed on substantially all sectors.
2nd: Countries that are not part of the agreement should not find trade with the newly created group any
more restrictive than before the group was set up.
The 2nd condition (previous slide): Countries that are not part of the agreement should not find trade with
the newly created group any more restrictive than before the group was set up.

A boom of bilateral agreements

WTO and bilateral/regional agreements

Why WTO members are so active in negotiating bilateral/regional trade agreements?
- After 1995 (when WTO as an institution was created) multilateral negotiations are not progressing: failure
of the Millennium Round (Seattle, 1999) and deadlock of the Development Round (Doha, 2001).
- Agreements among 164 countries are extremely complicated to negotiate (consensus as a principle).
- Negotiations are not focused anymore on tariffs, but more sensitive issues are at stake such as
environment and labour standards.
- Coalitions might facilitate the decision-making but divide the countries in separate fields such as free vs
protected agriculture, developed vs developing countries.

Why a network of bilateral/regional trade agreements is not a perfect substitute of a WTO multilateral
agreement?
- In bilateral negotiations, unilateral bargaining power matters (power- based trade thanks to divide et
impera).
- Non synchronization of bilateral trade agreements generates (negative) trade diversion, ie, efficient
exporters lose market shares abroad simply because their respective countries of origin are not part (yet)
of FTAs.
- A network of FTAs increase complexity of trade since each agreement has its own rules and
administrative requirements (see the rules of origin).
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Value Chains

Many tiers of a value chain

Global value chains

Global value chains (GVCs) are the natural
offspring of globalization:
-Reduction in transport, trade and
investments costs (due to technology, trade
and
investment liberalization).
-The growing interconnectedness of
economies and access to foreign markets
(inputs and
outputs). In GVCs economic activities are
fragmented and dispersed across countries.
-Specialisation of firms and countries in
tasks and business functions.
- Networks of global buyers and suppliers. In GVCs firms control and co-ordinate activities in networks
of buyers and suppliers, and multinational enterprises (MNEs) play a central role.
- New drivers of economic performance. In GVCs, trade and growth rely on the efficient sourcing of
inputs abroad, as well as on access to final producers and consumers abroad.

Traditional trade and GVCs

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Global value chains - Boeing 787 Dreamliner - Even for less complex products

Gravity model and GVCs

According to this model (Jan Tinbergen, a Dutch Nobel-prize winner), two simple points about the
geography of international trade.
1. Size. The bigger the GDP of the countries involved in a bilateral trading relationship, the more they
trade with each other. Larger economies have more demand for goods and services and offer more
products, supplying a broader range of consumers.
2. Distance. The farther away two countries are from each other, the smaller the volume of trade. That is
partly related to transport costs: sending a parcel from Britain to France costs half as much as sending
one to India. Cultural and linguistic differences also come into it. Exporters have a better feel for nearby
markets and can meet suppliers more easily geography may matter less than economists assume.

Towards a new EU’s trade strategy

Four drivers that triggered a new phase in the EU:
1) The WTO got stuck: the Doha Round is not
progressing and the Appellate Body is
not working (the U.S. is preventing the appointment of
its members).
2) Former President Trump thought that he inherited “a
significantly flawed trading system” that justified a
more confrontational and mercantilist U.S. approach,
imposing tariffs also on EU export.
3) In 2001 China joined the WTO but the expectations
of deep liberalization did not materialize: China ranks
first in EU’s antidumping tariffs and is purchasing
businesses abroad through its State-controlled enterprises that are allegedly subsidized by the State.
4) With Covid-19 trade is not flowing like it used to be. Lockdowns stopped manufacturing and shipping,
national security concerns stopped the export of essential/critical products such as personal protective
equipment and vaccines. Global value chains are as strong as the weakest link.

The new EU’s trade strategy

In 2020 the European Commission coined “Open strategic autonomy”. In the communication you read
(emphasis and comments added):
(...)The crisis has revealed a number of areas where Europe needs to be more resilient to prevent, protect and
withstand future shocks. We will always be committed to open and fair trade but must be aware of the
need to reduce dependency and strengthen security of supply, notably for things like pharmaceutical
ingredients or raw materials.
Open strategic autonomy will mean shaping the new system of global economic governance and developing
mutually beneficial bilateral relations, while protecting ourselves from unfair and abusive practices. This
will also help us diversify and solidify global supply chains to protect us from future crises and will help
strengthen the international role of the euro (...)
Alan Beattie (Financial Times) made fun of this new slogan that sounds like an oxymoron to appease the
free-traders (especially after Brexit), those who think they are sufficiently powerful to do the cherry picking,

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and those who love sovereignty and protectionism. He also invites to create your own slogan by choosing
one word in each of three columns here.

In February 2021 the Commission published the communication “Trade Policy Review - An Open,
Sustainable and Assertive Trade Policy” listing six policy areas:
1. Reform the WTO: eg, restoring a fully-functioning WTO dispute settlement with a reformed Appellate
Body.
2. Support the green transition and promote responsible and sustainable value chains: eg, the Carbon
Border Adjustment Mechanism (CBAM) as an autonomous measure.
3. Support the digital transition and trade in services: eg, pushing WTO agreement on digital trade
including rules on data flow and privacy.
4. Strengthen the EU’s regulatory impact by ‘exporting’ EU standard at an international level.
5. Strengthen the EU's partnerships with neighbouring, enlargement countries (Western Balkans) and
Africa.
6. Strengthen the EU’s focus on implementation and enforcement of trade agreements, and ensure a level
playing field. It is therefore important to create the conditions for the ratification of agreements with
Mercosur and Mexico, and to conclude ongoing negotiations, in particular with Chile, Australia, and
New Zealand, which are well on track.

Global value chains in the post Covid

- GVCs have brought many benefits by allowing firms to source their inputs more efficiently, to access
knowledge and capital beyond the domestic economy and to expand their activities into new markets
(perfectly consistent with Ricardo’s theory of comparative advantage).
- GVCs have also played a pivotal role in reducing poverty and offering an opportunity for developing
countries to grow and catch up with richer countries.
- Enter Covid-19. The closure of factories in China at the end of January 2020 drew attention to the
reliance of many manufacturing value chains on inputs from China.
- The subsequent lockdowns implemented all over the world have re-ignited the debate on the risks
associated with international production. This is why in countries like the U.S. and the EU you can read
about “re-shoring” and “industrial policy” : ie, reducing imports and revamping domestic manufacturing:
resilience now seems more important than efficiency (this also encompasses revisiting the just-in-time)..
- But don’t forget, no country is self-sufficient and a chain is only as strong as its weakest link.

LECTURE 11: 2.03

EU Single Market

Setup of the single market

With the Treaty of Rome (1957), the member States decided:
- to remove trade barriers between them,
- to set up a Customs Union (1968),
- to start the process of forming a Single Market (or common market).
In a single market, economic frontiers between member States are eliminated and the so-called four
fundamental freedoms (i.e. free circulation of people, services, capital and goods) would be guaranteed.

What does ‘single market’ mean?

- A market has got its distinct geography due to restrictions of different nature: physical (oceans,
mountains ..), economic (transaction and transportation costs), legal (exclusive rights, tariffs, standards ..).
- Market integration is a situation such that the flows of products, services and factors between countries
are on the same terms and conditions as within countries.
- This creates new opportunities for businesses, but also gives consumers wider choice and lower prices.
- In the single market price differences eventually arising among countries should be no more than the
cost of transportation plus related transaction costs.

The recipe for a single market

In order to change the geographic dimension of the market (i.e. from national markets to a single market),
States have to facilitate free circulation of goods, services, capital and labour by:
1) abolishing legal restrictions: no tariffs, no quantitative restrictions (quotas), no legal monopolies. -
European Single market

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2) promoting fairness in free trade: no public subsidies and protections granted in the domestic market to
national players or anti-competitive behaviours by national players. - Competition policy
3) reducing the impact of physical obstacles: building or upgrading transport infrastructure. - Trans-
European Networks
4) reducing economic costs: fixing exchange rates
between currencies, substituting national currencies
with a single currency. - Economic and Monetary
Union (EMU)
Implementing the single market
In order to maximize the gains from market integration, two
dimensions of potential costs/distortions have to be
eliminated, namely:

Keywords of the European Single Market

- Four fundamental freedoms. In the Treaty of Rome, the EU has the aim to achieve free movement of
goods, capital, services, and labour.
- Level-playing field. A market based on free and fair competition where everyone, independently of the
nationality, has the same chance of succeeding.
- Liberalization. It is the process of removing government control, reducing entry barriers (e.g.
authorizations and licenses) and opening up the markets to competition. Rail transport->example of
liberalized sector.
- Ownership neutrality. Usually liberalization goes with privatization (i.e. the transfer of ownership from
the government to the private sector). However in the EU, according to the principle of ownership
neutrality, State-Owned Enterprises (SOEs) are not illegal. However SOEs, as any other firm, cannot
receive a preferential treatment by any public institution.
Examples: The French State is the main owner of Renault (15.01%); 20% of the votes in Volkswagen are
in hands of the State of Lower Saxony State and the Italian State is the main owner of ENI (30.1%).

First step: elimination of tariffs and quotas

Second step: elimination of NTBs

- Elimination of tariffs and quotas is not enough if Non-Tariff Barriers (NTBs) keep markets fragmented
thus prevent the creation of a workable Single Market.
- NTBs might be imposed by countries to norm industrial production methods, standards for safety,
environment, consumer protection such as: Sanitary and phytosanitary measures and Technical measures
(eg, labelling).
- With the Treaty of Rome, the EU started a programme for the approximation of Member States’ national
legislations through directives and regulations.
- However, the progress in this area have been very limited, due to the application of the unanimity voting
rule in the Council of the EU (i.e., every Member State has the veto power) on all issues related to the
single market.
- Problem: the innovation is faster than the political decision-making, especially when every country would
like to propose its national standard as the European standard.

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NTBs according to the Court of Justice

A watershed moment was in 1979 with the “Cassis de Dijon” case …
- Crème de cassis (also known as Cassis liqueur) is a sweet, dark red liqueur made from blackcurrants.
- A German company requested authorisation from the German administration for spirits to import Cassis
into Germany from France.
- The response was that Cassis could not be marketed in Germany as there was a national rule which
required fruit liqueur to have at least 25% alcohol content (Cassis is between 15% and 20%).
- The German company then brought proceedings against that decision in the national courts and the
national courts referred to the CJEU for further guidance.
- CJEU, in the “Cassis de Dijon” judgement, established the principle of mutual recognition of national
rules -> we don’t need a legislation for every products, if it is legal in one country of the EU, it can be
sold wherever in the EU.
- This principle means that the legislation of another member State is equivalent in its effects to domestic
legislation.
- In other words, every member State is obliged to accept on its territory products which are legally
produced and marketed in another member State.
- This helped in eliminating the negative impact of most NTBs in place.
- However, the principle of mutual recognition is not enough to liberalize economic activities within the
European Single Market ... a certain degree of harmonization of legislation is required.

Third step: harmonization of legislation

- Many services are non-tradable (e.g. local transport, retail banking, mobile telecommunication); this
means that foreign firms cannot ship the service from their home country but they need to locate assets in
the target country.
- National regulations can block or can slow-down the entry of foreign firms. For example:
- being a dentist in Italy requires a certification issued by an Italian authority.
- an airport in Germany allows only German airlines to land and take-off.
- different rules to operate as a mobile telecom firm in different EU states.
- a common regulatory framework has to be in place to guarantee the right of establishment, i.e. the
possibility for every national of a member State to exercise its own economic activity in another member
State.
- Moreover, the EU wants to set common essential health, safety, and environmental protection
requirements. Only if manufacturers follow these common rules, their products can be sold freely in the
European market.
- ‘Common’ means: harmonization of legislation.
- In 1985 the Commission identified 282 regulations and directives to boost the completion of the Single
Market by dismantling two main categories of obstacles:
- cost-increasing barriers: (e.g. delays at borders, customs administration, or the need to comply
with different national technical regulation and standards);
- market entry restrictions: all measures preventing the right of establishment or trading across
frontiers in certain service industries (e.g. insurance or electricity) or professions, or the entry in
some regulated markets (e.g. civil aviation, public procurement).
- To facilitate the approval of the proposed regulations and directives, Member States amended the Treaty
of Rome with the Single European Act (SEA) entered into force in 1987.
- With the SEA, for single market legislation, Member States abandoned unanimity and adopted
qualified majority voting in the Council: with a majority system instead of unanimity, decision- making
is more efficient and member States lose the individual veto power.
Unanimity is still required for measures relating to fiscal provisions, freedom of movement for persons
and the rights and interests of workers.
- Those 282 directives and regulations were approved by 1992.
The institutional design - nowadays
- At the same time, a Council Resolution of 1985 implemented a new system for technical harmonisation
and standardisation.
- The harmonisation directives would, from then on, focus on the essential demands of health, safety and
environmental protection at the European level (general principles)
- Defining technical standards is left since then to specialised bodies such as CEN (European
Committee for Standardisation), CENELEC (European Committee for Electrotechnical Standardisation)

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and ETSI (European Telecommunications Standards Institute), and other specialised Committees
eventually set up at this purpose.
- From here on comitology started to emerge, as another important part of the decision-making process of
the EU.

Liberalisation of services: the proposal

- During the 90s the EU liberalised big service sectors such as civil aviation, telecommunication, energy
(before that liberalization it was common to have national monopolies or oligopolies protected by
national governments).
- The approach for those services was ‘vertical’, i.e. sector specific legislation (regulations and directives).
- In 2004, the Commission proposed an ‘horizontal’ directive to liberalise other services in the ESM
(European stability mechanism) such as:
management consultancy, certification and testing, facilities management (including office maintenance
and security), advertising, recruitment services, legal and fiscal advice, real estate services, the
organisation of trade fairs, car rental, travel agencies, health care services, household support services,
tourism, audio-visual services, leisure services, sports centres and amusement parks.
- The aim of liberalization? Again, to facilitate cross-border activity within the ESM.
- Absent an harmonized legal framework for those services, the Commission proposed the application of
the ‘country of origin principle’: a service provider is subject only to the law of the country in which
she is established and other Member States may not restrict services she provides.
- Surprise surprise, the idea of the Commission is not far from the principle of mutual recognition (do
you remember the “Cassis de Dijon” case?).
- Were the directive approved, a dentist who is legally practicing in Poland, can offer her services in
Germany subject to the Polish legal framework (e.g. taxation).
- Don’t forget, proposed directives need to be approved by the Council and by the European Parliament
(EP).
- The Commission’s proposal was labelled (especially by French and German socialists) as “ultra-liberal”
and the country of origin principle was an invitation to “social dumping”, in which competition from
poorer EU countries would drive down wages and welfare standards.

Liberalisation of services: the Directive

- After that ‘icy’ reaction, the European Commission modified its proposal eliminating the ‘country of
origin principle’ and reducing the range of services covered.
- In 2006 the Council and the EP approved the modified ‘Service Directive’.
- Now, according to the approved Directive, a dentist who is legally practicing in Poland, can offer her
services in Germany only after she gets an authorization by German authorities (if needed) and she will
be subject to the German legal framework ... and German taxes.
- So today, if you produce a car in Poland with Polish workers, paying Polish salaries, paying Polish
services (e.g. electricity) and Polish taxes, you can sell it in Germany without any type of restriction.
- But if you want to sell your Polish service as a dentist in Germany, you need to pay German taxes.
- Or, you can invite your German patients to drive a few kilometers and provide the full package (link 1,
link 2)

A soft liberalization of services with the Directive

- With the new ‘Bolkestein’ Directive, Member States have to be more ‘business friendly’ by simplifying
procedures (eg, setting up points of single contact to enable businesses access to information and
complete all procedures), by abolishing discriminatory requirements (eg, nationality or residence
requirements) and other restrictive measures.
- However, there are still national rules on professions across the EU, and they tend to have restrictive
effects on the cross-border activity.
- One common type of restriction is national rules that require a qualification/ certificate to be obtained in
that specific State, without taking due account of service providers' qualifications/certificates already
obtained in other Member States.
- In 2005 the EU introduced a system of automatic recognition of professional qualifications for nurses,
midwives, doctors, dentists, pharmacists, architects and veterinary surgeons.
- In 2006 the EU introduced the European Professional Card (EPC) for general care nurses,
physiotherapists, pharmacists, real estate agents and mountain guides.

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Online services and geo-blocking

Geo-blocking happens when online sellers/providers restrict online cross-border sales based on nationality,
residence or place of establishment.
In 2018 the EU adopted a regulation to ban unjustified geo-blocking in the internal market. For example,
now:
- A Belgian customer wishes to buy a refrigerator and finds the best deal on a German website. The
customer will be entitled to order the product and collect it at the trader's premises or organise delivery
himself to his home.
- A Bulgarian entrepreneur wishes to buy hosting services for her website from a Spanish company. She
will now have access to the service, can register and buy this service without having to pay additional fees
compared to a Spanish consumer.
- An Irish family wishes to visit a French theme park taking advantage of a family discount on the price of
the entry tickets. The discounted price should be available for the Irish family, just as it is for French
families.
Services where the main feature is the provision of access to and use of copyright protected content, such as
music, films, e-books, online games and software, are excluded from the scope of the regulation.

Is the single market delivering?

- The Community legislation governing the setup of the single market is largely in the form of directives
(framework laws).
- But directives require the adaptation of the national legislation via transposition measures from the EU
framework law to the national laws.
- This transposition has not been straightforward, leading to delays in the implementation of the single
market or an uneven playing field.
- For these reasons, on the one hand the EC regularly monitors the extent of the transposition deficit,
forcing non-complying countries to accelerate in the implementation of EU legislation (via fines that
could be imposed by the Court of Justice)
- On the other hand, the most controversial legislation (e.g. new rules on banking) takes the form of
regulation, as these are directly enforceable in each Member State to the letter, from the moment they are
published on the Official Journal of the European Union (OJEU).

To calculate the transposition

deficit of each Member
State, the Commission
includes:
•directives for which no
transposition measures have
been communicated
•directives considered to be
partially transposed by
Member State after it
notified some transposition
measures
• directives considered to be completely transposed by Member State, but for which the Commission has
opened an
infringement proceeding for non-communication and the Member State has not notified new
transposition measures after the latest procedural step taken by the Commission

The economic rationale of the single market

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Static gains
If competition is effective, the ESM:
- reduces barriers and costs of cross-
border economic activities;
- allows economic agents (firms and
consumers) to do business with the most
efficient partners (customer/supplier) in
a wider area;
- selects the European ‘winners’ i.e. the
efficient firms that can now serve a
wider market and can take advantage of
economies of scale.
Economies of scale means: the larger
the quantity produced, the lower the
average cost, thus lower prices for
consumers!
But the ESM gives an opportunity to the losers.
- Thanks to liberalization, workers and capital employed in inefficient firms can move
to another sector (within the same country),
- Thanks to free circulation of workers and capital, they can move to another EU country.
- EU rules for State aids allows governments to support the competitiveness of firms under special
circumstances and with conditions attached.

Dynamic gains with Solow’s growth model

The production function we are about to use is the Growth Model proposed by Robert Solow (1987 Nobel
Prize).
Basic assumptions:
- GDP (output) has three basic sources: Labor (L), Capital (K) and Total factor productivity (TFP).
- Annual output is either consumed or saved in fixed proportions.
- Closed economy, thus no trade.
- Full employment.
- Since TFP is calculated as a residual (the portion of GDP that is not explained by Capital and Labor), this
model is dubbed “exogenous growth model”.
- Decreasing marginal product of both capital and labor. This occurs when one factor is variable (e.g. labor)
and one factor is fixed (e.g. capital).

Dynamic gains in the medium-term

- Integration improves the efficiency of the

European economy by encouraging a more
efficient allocation of resources: this static gain
(allocation effect) shifts the GDP/L curve, i.e.
there is an upward shift in the underlying
production function, from f to f’ (more output
per worker is produced for any given K/L ratio)
- The shift up in the GDP/L curve also shifts up
the investment curve since the fixed investment
rate now applies to higher output and so
generates a higher inflow of investment for any
given K/L ratio.
- Schematically: integration → improved efficiency → higher GDP/L → higher investment-per-worker →
economy’s K/L ratio starts to rise towards new, higher equilibrium value → faster growth of output per
worker during the transition from the old to the new K/L ratio.
- This is the so-called medium-run growth bonus from European integration.

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If also the efficiency of the financial sector improves, the

marginal productivity of capital might rise and thus more capital
per unit of output is brought to the market. This yields a higher
investment rate: s’ > s thus generating additional growth.

Towards a capital market union

- The efficiency of the financial sector can generate additional growth. However, the financial sector in
the EU is far from being a single market.
- Even though free circulation of capital is one of the four pillars of the common market since 1958, there
are some obstacles to cross-border transactions that keep markets fragmented along national borders.
- Relevant rules (eg, company law, securities law, insolvency procedures, access to collateral) differ across
EU States: less competition, no economies of scale, less efficiency!
- Moreover, high bank dependency in the EU. If we consider firms’ liabilities, bank loans weight for 14% in
the EU and 3% in the U.S. while corporate bonds weight respectively 4% and 11%.
- High bank dependency means that firms, in particular the small ones, have difficulties accessing
alternative funding sources when they cannot get credit from banks. And, since the financial crisis (2008),
cross-border lending in the EU declined and banking activities migrated increasingly back to home
jurisdictions.
- Along with other factors, this explain why, notwithstanding its economic size, the EU’s financial system
has not reached the dynamism of the American one (there are very few European Apples, Amazons,
Googles and Teslas …)

- The Commission launched a capital markets union (CMU) initiative in 2015 but markets remained
fragmented. The Commission re-launched the CMU in September 2020.
- Why now? A strong and complete CMU is needed now more than ever, in order to support the economic
recovery following the COVID-19 crisis and finance the green and digital transitions.
- The CMU action plan proposes 16 actions such as:
- Action 1: Making companies more visible to cross-border investors: Establishing a European single
access point (ESAP) to provide for seamless, EU-wide access to all relevant information (including
financial and sustainability-related information) disclosed to the public by companies including
financial companies.
- Action 2: Supporting access to public markets: Making listing cool again.
- Action 7: Empowering citizens through financial literacy.
- Action 14: Consolidated tape to provide complete, accurate and comparable data on prices and
volume of traded securities in the EU, thereby improving overall price transparency across trading
(and competition between) venues such as stock exchanges.

Medium-term growth effects: EU accessions

Accession countries provide a natural experiment to evaluate the medium- term growth effects of
European integration since these countries experienced a rather sudden and well-defined increase in
economic integration when they joined.
1. stock market prices should increase (due to higher efficiency, thus profits and expected dividends);
2. the aggregate investment to GDP ratio should rise;
3. the net direct investment figures should improve.

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Long-run growth effects

- Can economic integration lead to permanently higher growth rates? ‘Qualified’ Yes:
- If the rate of technological progress is positively affected by market integration
- If tough competition as induced by the closer integration of the single market leads to continuous
productivity gains
- If structural reforms boost the potential growth of the involved countries
Any empirical evidence? Baldwin (1989) estimated a permanent 0.5% extra-growth per year. The EU
Commission (1996) estimated a permanent 1% extra-growth per year.

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