Economics of the European Union

In this essay I have been asked to analyse and compare the gains predicted by the economic theory from the removal of tariff barriers and non-tariff barriers within the Single European Market. In order to answer this question we must first have an understanding of the history and the purpose of the Single European Market and why measures such as tariff and non-tariff barriers play a major role when talking about trade. The creation of the European Union was seen as a major stepping stone towards creating a united “super power”; within which there was political harmony, economic stability and social co-operation between its member countries.

The moves to complete the Single European Market (SEM) and the progress towards an economic union focused attention on the European Union; who was seen as a key player in the process of European integration. It all dates back to 1952, where the foundations were laid of a European Community when the Treaty of Paris created the European Coal and steel community (ECSC) whose objective was to withdraw the French and German basic industries from the national authority and place them under a European High Authority. The sectoral limitations of the ECSC were felt to be a serious practical handicap and a greater integration was aimed at.

This was achieved in 1958 when the European Community (EC) was created by the Treaty of Rome which commits its original member countries (Belgium, France, Italy, Luxembourg, Netherlands and Germany) in establishing a single market (also known as Common Market) in order to create an economy within which member countries can experience remarkable gains from trade as well as being able to compete with the likes of United States and countries such as Japan in Asia. The move to establish a Single European Market (SEM) was simply a programme to enable the EU to create a single market.

As said before the EU has been committed to establishing the common market since the treaty of Rome was signed in 1957. Before agreement was reached to establish the market by the end of 1992, there had been little progress in creating this. The main problem being the difficulty in reaching an agreement about eliminating many non tariff barriers (NTBs’) based on diverse national rules, regulations, taxation and subsidies which hindered free movement of goods, services, capital and labour (known as the “Four Freedoms”) between the member countries.

This could only be achieved through the removal of barriers that prohibited the movement of the factors mentioned above. In the end, the creation of the single market was achieved and came into force on the first of January 1993. The free movements of the four freedom factors became an important principle of the European Single Market. It should be noted that it nearly took 40 years for the European Union to reach an agreement to create the market hindered by the barriers.

With the removal of the trade barriers and creation of the single market the main objective of the EU was to “enhance the allocation efficiency of the economic member countries by removing barriers to goods, services and factors of production”I. This would mean a fully integrated goods market between the member countries with the aim for free international trade; with potential economic advantages such as more production and prosperity through better allocation of each production factors, enabling each country to specialise in the production for which it has comparative advantage.

Coupled with more efficient production due to scale economies, better competition and improved terms of trade for the whole group in respect of the rest of the world. As said before integration of market implies first of all the removal of impediments to free trade of goods. Keeping this in mind it is important to establish what these trade barriers are. First of all we got the tariff barrier also known as the customs duties or import duties which are sums levied on imports of goods, making them more expensive on the international market. Levies such as these are based on value or quantity.

They may be in fixed percentages or variable amounts according to the price level aspired to domestically. Types of such levies are import levies often disguised in the form of administrative costs, storage costs or test costs imposed by the customs. Say for instance that if a tariff is placed upon value of imports would result in a rise in the prices of the domestic imports. The knock on effect of this would be the expansion in the domestic supply and the requirement of extra producers to meet this extra demand. This would enable the home producers to supply more at a higher price (only true when demand and supply is elastic).

Although tariffs are seen as a good thing as it encourages domestic performance in general by restricting imports, the downfall of it is that it affects international competition amongst its member countries. This will have a knock on effect on research and innovation which will result in a loss of what could have been either an improved commodity or service. In contrast non-tariff barriers are invisible and are all those measures, situations or actions taken that ensures a country’s own products’ receive preferential treatment over foreign products on the domestic market.

Examples of this would be fiscal treatment, legal regulations, safety norms, state monopolies, public tenders etc. Although it is not a physical barrier it is no less effect as an instrument of trade policy. But one main tool which is always used is s quantitative restrictions. These are ceilings put on the volume of imports of a certain good allowed into a country in a particular period (quota) which is sometimes expressed in a monetary value. A special type of this restriction is called the “tariff quota”, which is the maximum quantity which may be imported at a certain tariff with all quantities after that coming under a higher tariff.

Though quotas (NTBs’) impose a limit on international goods and increase the market share for domestic firms; it leads to rising prices on their goods and services within the affected member country to make up for the potential earnings that are lost through the restriction to cover their costs. Smaller countries in particular suffer and become victims due to the implementation of policies such as these. In order to eradicate this problem the EC created the Customs Union which is an area of free trade with common external tariff (Imports into the customs union pay the same level of tariff regardless of point of entry).

Though it doesn’t mean the complete removal of tariffs and non-tariff barriers but an area were the costs are reduced and goods can be traded without any sort of restriction. A good example of this would be the “Cassis de Dijon”II case which established the principle of mutual recognition. In this the European Court of Justice (ECJ) ruled that Germany were not entitled to ban the importation of Cassis de Dijon, an alcoholic drink from France, on the grounds that it did not conform to the German rules and regulations governing the sale of the product.

It went on to saying that products or services that adhered to the national rules and regulations in the member country where they were produced should be able to be sold in any member countries without the need to adhere to the rules and regulations governing the production and sale of the goods in the importing member country; a mutual recognition of each other’s rules and regulation. The verdict was one of the main reasons in starting off the removal of the internal market barriers. The use of the term “mutual recognition” was accepted by the EU when the new approach to technical harmonisation was adopted in 1985.

The bringing together of national rules and regulations were expected to bring about a stronger and increased competition including a larger economies of scale and efficient allocation. With this, further economic advantage were to be gained through trade creation (where it allows resources to be allocated according to comparative advantage), its main objective being the removal of tariffs by the customs union who lead the movement to trade from a high cost to a low cost firms/producers.

It basically indicates the cost advantages that can be gained by producing one type of good relative to the cost of producing another, the focus being on the concept of opportunity cost, the highly valued alternative. Its idea is that a particular country will specialise in a producing a specific good in which it has an advantage; where a country’s opportunity cost of producing the goods are lower than their trading partners. This means through specialisation they can now generate more output in relative terms.

Removal of barriers, both tariff and non-tariff, within the single market frees movement for the four freedom factors which will lead to net benefits similar to the one described in comparative advantage. An increased competitive market coupled with free movement increase and boost capital flow and production throughout the member countries. There is a potential growth as resources are used more efficiently and better use will be made out of the existing production processes. There is the possibility of further growth due to extra investment that will take place in order to meet the increased demands in the larger or existing markets.

With income growing, we know that savings will rise (theory of Robert Solow). With savings, investment goes up. Therefore we can see that free trade have two positive effects on growth created by the increase in efficiency and the trade in the larger market. With improved access to larger markets, there is the availability of information of new ideas of innovation, new product, processes which can be exploited for further gain. Economic theory suggests that new market opportunities allow for increased economies of scale and rationalisation through specialisation in segmented markets if the transport costs are low.

So far we can see that removal of non-tariff barriers like the frontiers can increase trade between member countries. On top of this it leads to incentives for investments. Greater the investment, the greater the competition and this leads to lower prices for the consumers. This would also mean a reduction in monopoly pricing strategies. It also weakens any sort of monopoly power as there are more sources of supply from other member countries within the European Union. It also means and increased output meaning net gains for consumers.

However there have been a growing number of arguments against the removal of tariff and non-tariff barriers. Obstacles to free trade are mostly meant to protect the country’s own trade and industry against competition from abroad. It’s a form of protection. It is economically true that barriers protect small firms, nurturing the so called “infant industries”. The idea here is that the young companies and sectors which are not yet competitive should be sheltered in infancy in order for them to develop into adult companies holding their own international competition.

It is also a case of strategic independence. This would mean in times of difficult periods (e. g. wars, supply shortages) a country should not depend on unreliable sources in other countries as far as strategic goods are concerned. Another argument against the removal of the barriers is the problems associated with the protest against both social and industrial dumping. If wages in the exporting country do not match productivity, the labour factor is said to be exploited. Importation from such a country is therefore not permissible.

From an industry point of view, the healthy industrial structure of an economy may be spoiled when foreign goods are dumped on the market below the cost in the country of origin. Even if it is temporary it may case the economy to weaken beyond its capacity to recover. It is also thought that by keeping the barriers employment in all sectors can be boosted. If the production factors in the union are not fully occupied, protection can turn local demand towards domestic goods so that more labour is put into work hence social costs can be avoided.

We can also ease our balance of payment problems by staying out of the EU. Import restrictions reduce the amount to be paid abroad, which helps to avoid adjustments of the industrial structure and accompanying social costs and societal friction in form of wage reduction and so on. Despite of all the reasons mentioned above we cannot deny the importance of the removal of the barriers in the single market. Too much nurturing of firms from competition with other member countries result in them becoming inefficient and a decrease in production levels.

All in all the single market is in the process of becoming a huge market for the European businesses and therefore all forms of barriers should be removed in an attempt to aid them. Another benefit according to the theory of trade is product differentiation. Once the barriers are removed trades can take place between the different markets within the member countries. It is believed (according to the theory) that the endowments of inputs of the various markets would be identical. But this contradicts with the theory of comparative advantage; saying that consumers prefer a wider choice of goods and services which will make them better off.

This is all motivated by the desire of the consumer who has different preferences in acquiring a variety of goods which matches their needs. Due to increasing returns of scale, all countries will specialise in producing a limited range of goods as there is the possibility of international trade which creates a market larger than the markets of individual countries. As said before, both tariff and non-tariff barriers are equally as effective as each other in their respective jobs as trying to prevent free trade.

Barriers such as these are unhealthy and slow down the process of economic growth in the different markets within the European Union. In terms of trade we usually think that physical exchange of goods between two parties must take place which is not the case, examples of this would be things like holidays, insurance and other forms of financial services which are intangible assets. Therefore the importance of having a free movement within the EU is imperative. There is clear evidence that non tariff barriers have, or is in the process of being removed unless you are a non-EU member.

Although the Treaty of Rome allowed member countries to retain such a barrier, the EU commission has been pushing to dispose them as completion of the internal market made it impractical as border controls were no longer permitted. As a result quotas have now been removed. When talking about progression in the removal of tariffs within the EU, we can say that the institution has been successful in achieving its objective of removing most tariffs if not all. As a result bigger market has been created enabling free movement of the four freedom factors.

In conclusion I would like to say that the attempts by the EU to integrate the markets of all the member countries have come a long way from the beginnings of the ECSC. The common union and the SEM programmes have helped in the sense that it has led to changes that has moved the EU towards a greater free movement. But, the legal and institutional and economic conditions for an effective free movement are not yet fully in place in the EU. The long haul towards creating a free movement area that was started by the Treaty of Paris (1951) still has a long way to go before the task can be completed fully.

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