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Economic Integration
1. Three levels of economic integration
•
Global: trade liberalization by GATT or WTO
– The World Trade Organization (WTO) is the only global
international organization dealing with the rules of trade
between nations. At its heart are the WTO agreements,
negotiated and signed by the bulk of the world’s trading
nations and ratified in their parliaments. The goal is to help
producers of goods and services, exporters, and importers
conduct their business.
– Location-Geneva, Switzerland
– Members—153 countries
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Regional: preferential treatment of member countries in the group
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Bilateral: preferential treatment between two countries
2. Four types of economic integration
a) FTA (free trade area)
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no internal tariffs among members, but each country imposes
its own external tariffs to the third country.
– NAFTA (North America Free Trade Agreement
– AFTA (ASEAN Free Trade Area)
– EFTA (European Free Trade Area)
b) Customs union
•
no internal tariffs and common external tariffs
– Mercosur (Southern Common Market)
– CACM (Central American Common Market)
– CARICOM (Caribbean Community and Common Market)
c) Common market:
• free movement of products and factors (resources), which
is customs union plus factor mobility
• EU (European Union – previously EEC)
d) Economic union
• common market plus common currency
• coordination of fiscal and monetary policy
– EMU (Economic and Monetary Union)
3. Economic effects of economic integration
• Static effects: Short-term effects (shift of production)
– Trade creation: production shifts to more efficient member
countries from inefficient domestic or outside countries.
• Dynamic effects: Long-term effects
– Cost reduction due to economies of scale
– Cost reduction due to increased competition.
History of European Union
a) Treaty of Paris (1951)
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Formation of ECSC (European coal and steel community)
b) Treaty of Rome (1957)
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Formation of EEC (European Economic Community), initially free trade area,
becoming a customs union in 1967.
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The Stockholm convention in 1960 created EFTA by seven countries to counteract
EEC.
c) Single European Act of 1987
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Creation of single market (Common market) effective on 1/1/ 1993
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Rename EEC by EU (15 members)
d) Treaty of Maastricht (1992)
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Creation of an economic union, EMU (12 members)
– Establishment of European Central Bank on July 1998
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Introduction of a common currency, euro on Jan. 1, 1999
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Circulation of euro on Jan 1, 2002
e) The Treaty of Accession 2003
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10 more countries became members of the EU 5/1/2004 (Cyprus, the Czech Republic,
Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia) and
Turkey became a candidate.
f) On 29 October 2004, European heads of state signed a treaty establishing the first constitution
for the European Union in Rome requires approval in national referenda.
g) 2007 Bulgaria and Romania became members of the EU. The EU has a population of 494m.
h) The Lisbon Treaty (2007) which after the rejection of the Constitution for Europe modified the
existing treaties, enhancing the efficiency of the decision making process and democratic
participation in a Union of 27 Member States.
2007
Population
Territory
Density
EU
USA
494 mln
303 mln
4.3 mln sq km 9.6 mln sq.km
1.7 mln sq mi
3.7 mln sq mi
114/sq km
31/sq km
Organization of European Union
a) European Council—heads of state, Brussels
b) European Commission--Brussels
– administrative body of 27 members (4-year terms)
– Initiate proposals; guardian of the treaties; implementing policies
c) European Parliament—Strasbourg, France
– 785 members elected according to population distribution
– Legislative body, but final decision by Council of Ministers
– Control over budget and supervision of the Commission
d) Council of Ministers/“Council of the EU”—Brussels, Strasbourg
– 27 different councils (agriculture, transport, etc.)
e) Others—Court of Justice, Court of Auditors, sub-committees
f) Policy Initiation, Analysis, Preparation, Approval, Implementation:
– EU Council of Ministers, representing national interests, holds strongest hand.
– Proposals from the Commission and amendments from the Parliament require
assent of the Council.
– Proposals rejected or amended by the Parliament can still be approved by
unanimous assent of the Council.
EMU (Economic & Monetary Union)
a) Common currency (Euro) area for 12 members
– European Monetary System (EMS) in 1979 introduced
European Currency Unit (ECU) and Exchange Rate
Mechanism (ERM)  European Monetary Institute (EMI)
in 1994  European Central Bank in July 1, 1998
– Euro became the official currency unit on Jan. 1, 1999.
– Euro is in circulation since Jan. 1, 2001
– U.K, Denmark and Sweden opted out.
b) Convergence criteria
– A high degree of price stability
– A stable exchange rate
– Budget deficit: no more than 3% of GDP
– Public debt: no more than 60% of GDP
– Convergence in long term interest rates
Remaining Issues of EU
a) Further elimination of barriers to common market
– Compatible standards and specifications
– No barriers to market access
– Coordination of VAT and other taxes
b) Expansion
– European Economic Area: extension of customs union privileges to EFTA
member countries (Norway, Iceland and Liechtenstein accepted. Switzerland
voted not to join), in force since 1/1/2004.
– Special agreements with Turkey and others
The European Model
I. Foundations
• Based on mercantilism-strong state is necessary to regulate and
control the domestic and international operations of a national
economy.
• Influence of Marx–indirectly thru his warnings about the inherent
stability of capitalism.
• Schmoller—antitheoretical approach; strong state is necessary to
correct social injustices and to regulate the economy.
• ideas of the social mkt economy
II. Legal Foundations: Civil Law
• Civil law—a code based legal system operated by
professional judges interpreting a detailed set of written
rules and regulations.
III. Features of the European Model
1. Corporate Governance
a) managerial capitalism replaces shareholder capitalism
– Managerial Capitalism-is a system of corporate governance that
places the interests of stakeholders above those of shareholders
– More emphasis on the interests of all "stakeholders": efficient
management vs employee loyalty
– Advantages
• provides more stable employment; create a more equal distr of income
within company; technological improvements.
– Disadvantage
• lower efficiency.
b) Shareholdings
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Corporations typically controlled by small number of investors and banks
often have substantial interests; whereas shareholder corporations in the US
tend to be broadly owned by a large number of investors
stakeholder corporations in Europe tend to be held by a smaller number of
investors many of whom hold a significant stakes
c) Insider Trading
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Insiders (managers, board members, etc) have more info about
corporation’s performance than do public shareholders.
In Anglo-Saxon countries, stock exchanges &security commissions have
more strict laws against insider trading than those in Europe.
d) Transparency
–
The transparency requirement is less vital in a stakeholder company
e) Less active mkt for corporate control
f) Codetermination
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–
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allowing worker representatives on management boards
workers have a say in management decisions
used widely in Germany, France and Italy, e.g. German law
requires that shareholders and workers have equal numbers
on boards of directors and are represented by enterprise
councils.
Codetermination is one of the most distinctive features of
the EM b/c it formally gives non owners of companies
(employee) the same rights as owners to make decisions on
how property will be used
supporters—codetermination has maintained peaceful labor
relations; critics—it threatens private property
2. Capital Markets
a) Companies finance primarily through bank lending
– bank provides start-up capital.
– bank holds shares and is represented on board of directors
b) Universal banks
– European banks perform not only traditional banking but also
stock brokerage and merchant banking
– Advantages of bank financing:
• Banks examine business risks carefully;
• Banks diversify their risks
– Problems—limits the degree of competition and innovation
in the financial sector.
c) Dynamism
– the capital mkt and its corporate governance do not allow
capital to be allocated from declining to rising industry.
3. The Labor Market
a) Labor unions
– higher share of workers are unionized than the US; strong
political role (e.g. England, through the Labor Party)
b) Much more highly regulated than that of the US
– EU directives set regulations:
• equal pay, minimum annual paid holidays, hours of work, portability of
pensions, health and safety, maternity and paternity leave, gender equality
• two-yr maternity leave in Germany and provision in Sweden for parents
to take 480 days off for each child at 80% pay;
• 35-hour work in France;
• Germany-unemployed workers qualify for unempl insurance for 32
months and are not required to take open jobs that necessitate their
moving or that offer lower wages than they had earned before.
c) Employers cannot easily fire of lay off workers
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elaborate procedures and approval of works councils required for
significant layoffs, e.g. German law, 30 days before any termination,
firms must inform the state employment office and the works council.
d) EU Works Council directive (enacted in 1994) requires employers
to consult and inform employees
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“social dumping": transfer of production to lower cost jurisdiction (e.g.
Renault case)
e) Hours worked per employed person much lower than in the US (in
2001-US-1,800 hours per year; Italy 1,600; France-1,500; Germany-below
1,500; Korea-2,390)
f) Results of regulation:
– High Costs of Regulation
– High priced and inflexible labor (Costs of labor inflexibility
are not included in the monetary cost of labor; employers
unable to lay off workers in bad times)
– strong disincentives to growth and job creation
– High unemployment -8-11%, in US-5-7%
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Virtually no increase in private sector jobs over past 20 years
High long-term unemployment
High youth unemployment
High unemployment among unskilled-wages too high relative to
skilled?
– Unemployment geographically concentrated - low mobility
of labor
Annual hours worked per employed person, 1996 and 2006
In both years, Koreans worked the most hours annually.
The Republic of Korea and Ireland experienced the largest reductions in annual hours .
Source: US Dept of Labor; Report: A Chartbook Of International Labor Comparisons: The Americas, Asia-Pacific, Europe —
January 2008; http://www.dol.gov/asp/media/reports/chartbook/2008-01/index.htm
Unemployment rates, 2006
Most of the European countries had higher unemployment rates than the US.
The Republic of Korea, Norway, and Mexico had the lowest unemployment rates.
Unemployment rates for youth, 2006
Italian teenagers had the highest unemployment rate, followed by their counterparts in
Sweden and France.
Unemployment rates for teenagers were higher than those for 20- 24
Persons unemployed one year or longer, 2006 as a % of total unemployment
Long-duration unemployment was least prevalent in the Republic of Korea and Mexico.
The EU-15 countries combined had a relatively high percentage of persons unemployed one year
or longer. More than half of the unemployed were without work for at least one year in Germany,
Italy, and Portugal.
• European countries deal w/ the problem of unemployment
differently:
France and England
• Incentive to substitute part time jobs and temporary workers
Germany
• Hartz commission (Peter Hartz, Volkswagen personnel
director): asked by govt. to make proposals to deal with high
unemployment (9%, 4 million)
– “job centers" to help unemployed find work
– Agency to employ jobless people and hire them out to private
companies as temporary workers; lose benefits if refuse offer
– unemployed required taking pay cut; young singles may have to travel
to another part of the country; must justify refusal to take job offered
– Reduction in maximum period of unemployment benefits
– Tax incentives to encourage people to set themselves up as selfemployed
“Intricate workings”--Jun 15th 2006, The Economist
• Tackling unemployment requires a careful mixture of policies.
• OECD 2006 Jobs Strategy (mainly in Europe) to reduce high
and persistent unemployment rates.--“There is no single road to
better labor markets.”
– France, Germany and southern & central Europe, too few people work.
– People aged 55 or over--70% of Swedes and 61% of Americans aged 55
to 64 work; only 32% of Austrians, Belgians and Italians
– Too many countries have allowed or even encouraged older workers to
drop out early.
Reasons for unemployment:
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Highly regulated labor markets
No job creation
Generous unemployment benefits
High minimum wages and tight job-protection laws can make employers
unwilling to take on new employees, especially young ones who are untrained and
untried.
• A thick wedge of taxes between what workers take home and what it costs to
employ them can both discourage people from working and make firms reluctant
to hire them.
• People w/o jobs may lack the education/ skills that employers require.
Policies to raise employment
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Deregulating the labor markets—flexible labor mkt with weaker job protection
Job creation
Trimming marginal tax rates
Making benefits less generous.
Old before their time--Mar 3rd 2005, The Economist
Early retirement:
– Generous European pension and early-retirement schemes, along with
disability and unemployment programs
– Low minimum retirement ages
– Indeed, past policies were partially intended to encourage people to retire
early, to create “room” for younger workers.
The OECD has attempted to measure the implicit “tax” on working
for someone nearing retirement age. This tax measures the
pension and other benefits that old people forgo when they
continue to work, expressed as a proportion of their wage.
– For 55-year-olds in Germany or France, this implicit tax amounts to 50%
of the average wage for people in that group.
– For 60-year-old Dutch people, the loss of benefits is 90% of the wage
– Belgians face an effective tax rate of 80%.
A tale of two Frances--Mar 30th 2006 The Economist
New labor rule --to encourage employers to create jobs, particularly for illqualified youngsters by giving them a two-year trial period, after which full job
protection comes in, i.e. to loosen the firing rules for the young.
Young French people:
• Face a high unemployment rate
• They also find it difficult to break out of a cycle of back-to-back
short-term contracts.
• Over 64% of French 15-24-year-olds in work are on temporary
contracts one year after leaving education.
• The reason that these jobs are the best on offer is that permanent
jobs are so protected that employers hesitate to hire.
• The potential trade-off—between less security and more jobs—is
not the way the students see it.
“Today's protests are based on the defensive, the fear of insecurity
and of change.”
IV. Nationalization, Privatization, Deregulation
1) Public ownership
• Reasons for nationalization—ideology, national security, maintain
employment, regulate natural monopolies, provide for external
benefits in industries such as health care.
– F. Mitterrand (socialist): extensive nationalization in France in early 1980s
in industry, transportation and largest remaining private banks.
• Problems—many of the nationalized industries fail to turn a profit
and require subsidies. However, they were often nationalized to
pursue goals other than profit maximization.
2.) Nationalizations were followed by privatizations of major
industries.
• in mid 1980s when the conservatives returned to power, policy then
reversed: privatization of several large companies
• Privatization pursued in Britain under Margaret Thatcher (several
industries sold to stockholders): the first privatization of large
company British Telecom, British Gas, British Airways, RollsRoyce, British Steel, British Coal, and British Rail. Some have
become profitable. Raised revenue for budget and created new
group of stockholders.
• Benefits of privatization-performance improvement (sales,
profitability), sustained employment- British airways became more
innovative and profitable after privatization. Critics say that the
government sold the assets too cheaply, that profits are excessive,
and that firms should not be allowed to exercise monopoly power.
Recent trends
• European countries have begun to initiate privatization &
deregulation.
• UK: companies in public ownership-1979: 12% of GDP; 1997: 2%;
• France: partial privatization of France Telecom, Air France, Renault,
Thales (defense & electronics)
• Germany: privatization of Deutsche Telecom, Deutsche Post
• Recently momentum has stalled; sales have declined from peak in
1998; weak stock markets
• "strategic" industrial holdings - govt. maintains some shares, controlling
interest in some cases
• e.g. France
France Telecom 55.5%
Air France
56%
Thales
33%
Renault
25%
EDF (French electricity supplier) – monopoly in France but has taken over suppliers
in other European countries till 1999 when the first EU directive to harmonize
regulation of electricity mkts was implemented
3) Deregulation
• Pursued by Thatcher in Britain in 1980 and also strengthened the
economy.
• has been promoted by EU as part of the single market: gas and
electricity and air travel were open to competition
V. French Indicative Planning
1) Features:
Planning initiated after WW II to rebuild the capital stock. Planning
was never meant to replace the market, but to improve its operation.
Headed by General Planning Commissariat, much work is
performed by Modernization Commissions, with labor,
management, and government representatives. The Economic and
Social Council reviews plan documents as they are formulated and
Regional Development Commissions sponsor regional economic
needs.
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No compulsory targets are prepared for enterprises.
Planners project probable trends in the economy.
Compliance with the plan is purely voluntary.
The plan should indicate to enterprises the planners’ best estimate of the
course of the economy.
– Mechanisms for plan implementation—budget and public ownership.
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The government urges compliance through influence over
nationalized industries and banks, monetary and fiscal policies.
After 1970 the French planning was of limited importance
VI. Income Security:
1) The importance of safety nets to provide income and employment
security
2) Econ security is provided by the state, w/ greater generosity than in
the Anglo-Saxon M w/ its emphasis on individual reliance.
3) Sweden –econ security, including full employment, &
egalitarianism, which included both reducing income differences
and eliminating poverty.
Swedish Model
It is an example of market efficiency with socialist equity; in terms
of the mechanisms used to allocate resources, Sweden is a market
economy.
Features of the Swedish Model:
• Mostly private ownership of the means of production
• Large public sector financed by high and progressive tax rates
• Centralized wage bargaining to even out wages—developed after WW II.
Employers wanted more orderly bargaining. Unions wanted wage solidarity
(largest wage increases to the lowest-paid workers). Wage negotiations take place
at the national level. During 1945-1970, central bargaining worked well. In 1970
departures from the central agreement became common and inflation rose above
the average of other industrial countries. Disagreements over wage solidarity
have weakened the system.
• Active labor market intervention—programs to increase the demand for labor,
programs to prepare labor to new job openings, and to match supply and demand
through job information and placement services.
• Welfare system-universal coverage
• Unemployment benefit of 90% of gross wage
• Generous retirement and disability pensions-state pension of 65% of previous
income
• Income support provided to parents who stayed home to care for children; family
allowances for children (about $135/month/child until age 16)
• National health insurance
• free public education through graduate school.
• Sweden very successful in reducing inequality-the most even
distribution of after-tax income in the West.
• Welfare state successful in 70's & 80's
Problems
• High cost—social spending represented 29% of national income in
2002, compared to 21% OECD average (but down from 37% in
Sweden in 1993). Total taxation was 51% of GDP in 2001, compared
to 37% OECD average or 29% in USA.
• High taxes have driven a significant part of income and production
underground in the form of do-it-yourself home improvements and
barter activities.
• High unemployment-8% in 1995
• High debt (90% of GDP) & deficits (10%)
• Slow growth - further reform needed?
• Disincentives - e.g. unemployed person not obliged to take job
unrelated to previous occupation
VII. Reforms
“Remodeling Scandinavia” (The Economist, 8/23/97)
1. Reduced taxes and benefits
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Sweden has cut benefits and marginal rates of income tax
Denmark has cut top tax rates.
2. Unemployment benefits have become less generous.
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Denmark -unemployed youths must join vocational-training programs
Norway has cut the duration of unemployment benefits (to a still-generous 3 years).
3. Pension costs
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Norway is salting away a big chunk of its oil income in a State Petroleum Fund to
help pay the pensions of its ageing population when oil and gas production tails off
Finland raised the retirement age.
4. Wages and working conditions are still largely set by centralized agreements
among powerful trade unions, employers and the state (keep minimum wages high
and, in the name of equality; narrow the variation between low- and high-wage jobs
and industries. Unskilled workers cost too much and the talented have too little
incentive to invest in their education, or to switch from lackluster industries to
booming ones.
5.
Job-creation programs
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Sweden's new 4year job-creation program relies heavily on getting adults into
higher education, upgrading infrastructure and early retirement.
Germany:
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Reform process begun by Christian Democrats under Helmut Kohl (became
Chancellor in 1982): tax reductions, deregulation of labor markets, and
privatization (Volkswagen, Deutsche Telecom)
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continued by Social Democrats under Gerhard Schroder - reduced expenditure
including state pensions and other welfare benefits; commitment to reduce
public debt
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Tax reforms (July 2000) - cut in top rate of corporate tax and income tax
France
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Tax Cuts:
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Lower income tax rates in all brackets; remove disincentive at bottom end
for seeking work
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Lower social security contributions from the low-paid
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cut in corporate profits tax
Health Care
France: "Under a financial anaesthetic" [Economist, 01/12/02]
• French health care system rated first among 191 countries by WHO
• spends under 10% of GDP (US: almost 13% and ranked 37th)
• Most of doctors' fees paid by state insurance; poor and unemployed get free
cover
• Problem of overuse; share of GDP has risen by more than a quarter over 20
years
• Future rise in proportion of older people in population
Germany: "Is it enough?" [Economist, 6/7/03]
• Highest spending as % of GDP (11%) of all European countries.
• Services are free: problem of overuse
• Demographic shift as in France
• Proposed Reforms
• eliminate coverage for glasses, artificial insemination, over-the-counter drugs
• Larger payments for prescription drugs
• Increase in cost of hospital stays (e12 instead of e9)
Source: BBC news In Graphics: Comparing welfare states
http://news.bbc.co.uk/2/shared/spl/hi/pop_ups/05/business_comparing_welfare_states/html/1.stm
The welfare states of continental
Europe and social democratic
Sweden seem better at tackling
poverty than either the UK or the
USA.
The effectiveness of welfare
states in combating poverty is
closely related to how its
citizens are prepared to spend.
Sweden, where total state
spending makes up 60% of the
economy, also spends twice as
much on social welfare as the
United States.
Britain falls between the lowspending USA and the highspending continental European
countries.
The US stands out as the only
industrial country which only
provides limited government health
care benefits -mainly to the elderly.
Other people must buy private
health insurance through their
employer.
Britain's NHS provides a universal
service, although not the bestfunded one, with particularly
generous prescription drug
coverage.
The most dramatic differences
in welfare provision occur in
regard to unemployment.
Liberal welfare states like the
USA and the UK provide a sharp
cut-off in benefits to discourage
dependency and force people
back to work.
Germany and France provide
generous benefits, and some
argue this leads to high
unemployment and inflexible
labor markets.