Economic integration can be defined as a long-term process in which several stages improve the level of integration. The first step is a free trade area in which internal visible trade restrictions (customs duties, quotas) between partner counties are removed. Examples for those forms of economic integration are the North American Free Trade Area (NAFTA) and the Asian Free Trade Area (AFTA). Adding a common external tariff for non-member countries to the elimination of internal trade obstacles creates ensuing a Customs Union. The next level of integration, the single market for commodities, is achieved by removing visible and invisible trade barriers. Therefore all restrictions on trade between member-countries are abolished and a common external tariff is imposed on external countries. Following to this level free factor mobility of production and of financial assets generate a common market. Next steps to economic integration are the Monetary and lastly the Economic Union by having a common currency and policy. Theme of this essay is critical arguments of disestablish trade barriers towards the European Union (EU) and its underlying economic theories in respective to the Single Market Programme (SMP), its aims and if they are achieved in terms of labour and social policies. Therefore it is necessary to have a focus on the removal of non-tariff barriers (NTBs) exemplary for goods and labour.

However what are the reasons for economic integration? The answers are given by the theories of Customs Union (CU).

Economic integration is based on welfare effects caused by specialisation and trade. There are short-term static (trade creation, trade diversion) effects of integration and long running dynamic effects (economies of scale, terms of trade) that amplify or weaken the static effects.

It is assumed that there are a small CU, perfect competition, a partial equilibrium, perfectly elastic world supply and decreasing returns to scale in all countries. Also the CU imposes a tariff on the world price, which is less than the partner’s price. Because the partner’s price is less than the domestic, the so-called trade creation occurs: demand switches from the expensive production to the cheaper production. Furthermore, there is a gain in macroeconomic ¹ efficiency through a saving in production costs on the one hand and on the other hand through available resources

¹ A sophisticated view to gains and losses concerning individual members may disregard.

^th ed., pp. 99ff. For a closer view: W. Molle (2001), The economics of European Integration, 4

1

country of more expensive production costs. In the long run and under imperfect competition assumptions (see below), demand in the cheaper producing country increases and furthermore scale economies may exploit which means advantages in production costs and greater trade creation gains. Especially European countries are relative small in size and therefore they trade intensively with both, European countries and the rest of the world. For that reason it made sense removing all national barriers to become one equal competitor to the USA and Japan. Also consumers gain in welfare through trade creation, namely a higher relative income, by a reduced price at the expense of real income to the community, in other words the tariff revenue. A reduced price may leads to increased (domestic) consumption, the so-called trade expansion that provides a multiplier effect on economy and may generate more investment and furthermore production and economic growth. ² However, by imposing a tariff on the cheaper world price, demand switches from the cheaper world production to the un-taxed partner production, the so-called trade diversion occurs. Furthermore there is a loss in efficiencies in terms of the world’s efficiency that doesn’t concern the CU, however there is a loss in welfare due to the trade diversion effect of obtaining the more expensive partner import rather than the cheaper world product. ³ “The net gains from the CU thus depend on the relative size of the trade creation and trade diversion effects. These will depend on the relative efficiency of domestic, partner, and world suppliers and on the domestic elasticity of demand for the product.” ⁴ In other words they are depended on the elasticities of demand and supply in both, home and partner countries. Under the assumptions of imperfect competition (increasing returns to scale, product differentiation, segmented markets, elasticities of substitution) CU leads to exploit economies of scale and more competition will lead to reduced profit margins, increasing intra-EC shares and lower costs, hence better allocation and welfare is gained. Competition reduces costs by removing X -inefficiencies within companies, prices will fall, output decreases while intra-EC trade falls as well as extra-EC export increases and imports fall. Profit falls and consumer gains are greater caused by competition. 5

² J. Hansen/ J. Nielsen (1997), An Economic Analysis of the EU, 2 ^nd ed., Berkshire, pp. 76f.;

³ J. Hansen/ J. Nielsen (1997), p. 21f.;

W. Molle (2001), pp. 96-101;

P. Robson (1998), The Economics of International Integration, pp. 31-5;

R. W. Vickerman (1992), The Single European Market, p. 8-12.

⁴ R. W. Vickerman (1992), p. 9.

⁵ C. Allen/ M. Gasiorek/ A. Smith, The competition effect of the Single Market in Europe, in:

Economy Policy, Vol. 13, No. 24, p. 441-7.

2

However, tariff barriers were replaced by NTBs furthermore the trade creation effect was reduced. Their removal has a similar effect to tariff (see above). ⁶ Peoples fear to become highly depended on imports and the results of a free trade area made the EU to establish a research programme, the so-called “costs of non-Europe or Cecchini-Report” which should measure the impacts of implementing the Single Market (SM) and existing costs of trade and production because of NTBs like public procurement, border controls, different technical standards and fiscal differences. It was designed as an ex-post evaluation to estimate cost reduction by reducing trade obstacles and estimates potential economies of scale chaired by Paolo Cecchini. The Single Market Programme (SMP), which is based on the results of the Cecchini-Report, was designed to generate structural changes in the EU. It focused on removing NTBs by 1992 to improve competition and hence welfare and efficiency (see above). ⁷ It covers the following areas:

• Liberalization of trade of goods, through elimination of border and fiscal formalities and abolition of technical barriers to trade

• Liberalization of cross-border public procurement

• General deregulation and more active enforcement of competition policy in all sectors

• Liberalization of trade factors, trough among others abolition of capital mobility controls

• Liberalization of cross-border service provisions and abolition of restriction to establishment 8

The underlying idea was to reduce complexity of the trade environment in terms of member countries by harmonizing taxation, regulations, national laws etc and furthermore to reduce imperfections of the market. Free factor mobility should be achieved. The outcomes of this are increased competition and would result to structural changes, which offers the possibility of exploiting economies of scale, reducing prise. This would stimulate demand, lower costs and furthermore better

⁶ Vickerman (1992), p. 12.

⁷ European Commission (1998), Aggregate Results of the Single Market Programme, The

Single Market Review, Vol. 5, p.11ff..

⁸ European Commission (1998), Aggregate Results of the Single Market Programme, The

Single Market Review, Vol. 5, p. 15.

3