Lecture 1: Customs Union and the Internal Market
International trade makes more efficient use of production factors through specialisation and
through economies of scale (being able to produce at a larger scale)
3 Trade Theories
1. David Ricardo 1817: Neoclassical Trade Theory
“International trade is driven by comparative cost advantage”
Countries should specialise in the product they produce more efficiently
According to Ricardo’s model, self-sufficiency is less desirable as trade through exchange creates
greater prosperity for both countries
2. Heckscher-Ohlin Theory 1930s
Ricardo’s theory fails to address why countries have a product in which they are most efficient in
producing
Heckscher-Ohlin outline the factor endowment of each country: if there is surplus labour within
a country, then a country should specialise in labour intensive products / if there is a surplus in
capital within a country, then a country should specialise in capital intensive products
3. Krugman & the New Trade Theory
Krugman seeks to understand intra-industry trade (trade within the same industry)
Intra-industry trade is driven by differences in taste within the same sector
Aside from the benefits from international trade, there is still high protectionism amongst nation
states mostly to protect domestic economies and products
Background: War-time Global Protectionism
1926-1938: there is a reduction in world trade, due to a global protectionist turn
After WW2, there are calls for trade liberalization – most notably by the USA (who were mass
producers during the wartime era)
GATT (General Agreement on Tariffs and Trade) 1947 = called for a substantial reduction of tariffs and
other trade barriers
In 1948, the Benelux countries initiated a customs Union
Roadmaps to Economic Integration
Free Trade Area (EFTA): lower degree of integration and more bureaucratic
Customs Union (EEC) – completed in 1968: negative integration (removal of barriers and
establishment of common external tariff)
EFTA countries suffered significant trade diversions as they were unable to trade with the EEC
because of the common external tariff
,Free Trade Area versus Customs Union
Why would a country join an FTA?
- There are no internal trade or tariff barriers
- There can be, however, variable foreign import tariffs set by participating member states
- Import tariffs are a tax ascribed to imported goods, that exporting suppliers pay to the
national government in which they are importing product from
- Employing an import tariff is beneficial to the importer because it helps protect domestic
goods (as in comparison domestic products will be relatively cheaper for domestic
customers), and it can also help infant domestic industries grow (as they can be free of
international competition)
Variable import tariffs means that trade will most likely be deflected through the lowest tariff country
to the highest tariff country – resulting in individuals seeking a profit: they can travel from low tariff
areas and sell for profit in high tariff areas (this is called trade deflection)
What would be needed to fix trade deflection in a FTA?
- Certificate of origin – so that import tariffs can be correctly paid between FTA borders
- High customs surveillance – of what is entering and leaving a country (to potentially be sold
elsewhere)
Why would a country join a customs union?
- Common External Tariff
- Removal of administrative and bureaucratic processes
Why would there be hesitance to join a customs union?
- It requires that sovereignty is given up when it comes to setting an import tariff
- It requires for all participating members to be somewhat politically integrated, so that
negotiations can take place over the setting of common import tariffs
Trade Creation and Trade Diversion
Joining a FTA increases international trade because of the absence of an import tariff, that may have
resulted in international partners’ products being more expensive – thus not imported this is
called trade creation
Trade diversion (sometimes referred to as supply switch) occurs when countries within an FTA import
other participating countries’ products rather than importing outside of the FTA (because although
the cost might be cheaper, the import tariff makes the purchase more expensive)
Common Agricultural Policy (CAP)
Agriculture remained outside of the trade liberalisation of the customs union – it was not open to
free trade amongst EEC members
Background CAP
1962: CAP began as a simple price support policy – in which subsidies would be given to smaller and
poorer farms meaning the more goods you could produce, the more money you could make by
selling it to the EU
,The Green Revolution and its consequences
The Green Revolution denotes the 1970s rise in agricultural efficiency (with the use of pesticides and
more efficient farming techniques) the supply in agricultural goods significantly increased after
this, resulting in overproduction
In spite of overproduction, there are still more efficient producers in agriculture outside of the EU
With the world price being relatively low, the EU must protect EU goods by raising the import tariff
so that EU consumers are more likely buy EU agricultural goods
EU farmers are generally less efficient than other global producers, so the EU set a common price
floor so that European farmers could less their produce at a standardised price to the EU for export
What EU overproduction meant for the EU budget: the EU had to sell surplus products for world
price (much lower than what they purchased it for with the farmers) whilst still paying European
farmers in the form of subsidies the EU budget began to become consumed by the payments
under the CAP
Consequences of the CAP
- Overproduction, resulting in intensive agriculture
- High prices of EU consumers
- Welfare loss
- Inefficient producers were safeguarded
- Costly – 1/3 EU budget
Lecture 2: Completion of the Single Market
The initial successes of the EEC6 Customs Union:
- Increase in intra-EU trade (resulting in trade creation)
- By 1990, 2/3 of imports came from inside of the customs union
1970s: Economic Stagnation
End of the postwar economic expansion period (1945-1973), triggered mainly by:
- The first oil crisis in 1973
- The collapse of the Bretton Woods system 1971
- High inflation
This period is coined as a decade of stagflation (stagnating economy + inflation)
The dominant economic paradigm (Keynesian economic thought) was in decline
1979: Second Oil Crisis shocked EU economy
1980s
American central bank launched anti-inflationary policy with high interest rates it made borrowing
money and investing it more expensive, which led to an US and EU recession
Unemployment crisis in the EU
, Eurosclerosis: describes a pattern of economic stagnation that results from government over-
regulation (the welfare state made the labour market inflexible to adapt to shocks)
EU economies were fragmented, there was little specialisation and economies of scale
1985: Rebirth of European Integration?
Jacques Delors became the president of the Commission (1985), seen as the driving force behind a
new wave of further EU integration
He introduced the Single European Act (1986) that established the completion of the internal market
and the Delors Report (1989) that established the EMU, and formed the basis of the Maastricht
Treaty
Completing the Internal Market
White Paper proposed by Lord Cockfield contained 300 measures to remove trade barriers with a
structured timetable
1986 Single European Act (Delors)
- Creation of an area without internal frontiers
- Followed up on the White Paper
- Sped up decision making in the Council
- Introduced the Single Market Programme (SMP) programme to remove non-tariff barriers
by 1992
Non-Tariff Barriers (NTBs)
All other trade barriers other than taxes e.g. differences in regulations and standards / border
controls etc.
Cockfield and his Commission distinguished different NTBs:
1. Physical barriers reducing border formalities
2. Technical barriers eliminating different national regulations and standards (mutual
recognition)
3. Fiscal barriers indirect taxes (e.g. VAT) / tax competition
It was hoped that these policies would lead to economic growth in these ways:
1. Reduction of economic rents less of a monopoly on power
2. Reduction of X-inefficiencies by increasing competition, efficiency in production should
increase too
3. Economics from restructuring production process is restructured because of the increase
in competition
Criticisms
- Main stream interpretation market integration is good for consumers
- However, on the other side of things, you could say that most of this economic integration
serves big businesses
- Many of Cockfield’s ideas came from lobbyists (mainly big companies in Europe)
- Completion of the internal market = “EU is an engine for neoliberalism”
International trade makes more efficient use of production factors through specialisation and
through economies of scale (being able to produce at a larger scale)
3 Trade Theories
1. David Ricardo 1817: Neoclassical Trade Theory
“International trade is driven by comparative cost advantage”
Countries should specialise in the product they produce more efficiently
According to Ricardo’s model, self-sufficiency is less desirable as trade through exchange creates
greater prosperity for both countries
2. Heckscher-Ohlin Theory 1930s
Ricardo’s theory fails to address why countries have a product in which they are most efficient in
producing
Heckscher-Ohlin outline the factor endowment of each country: if there is surplus labour within
a country, then a country should specialise in labour intensive products / if there is a surplus in
capital within a country, then a country should specialise in capital intensive products
3. Krugman & the New Trade Theory
Krugman seeks to understand intra-industry trade (trade within the same industry)
Intra-industry trade is driven by differences in taste within the same sector
Aside from the benefits from international trade, there is still high protectionism amongst nation
states mostly to protect domestic economies and products
Background: War-time Global Protectionism
1926-1938: there is a reduction in world trade, due to a global protectionist turn
After WW2, there are calls for trade liberalization – most notably by the USA (who were mass
producers during the wartime era)
GATT (General Agreement on Tariffs and Trade) 1947 = called for a substantial reduction of tariffs and
other trade barriers
In 1948, the Benelux countries initiated a customs Union
Roadmaps to Economic Integration
Free Trade Area (EFTA): lower degree of integration and more bureaucratic
Customs Union (EEC) – completed in 1968: negative integration (removal of barriers and
establishment of common external tariff)
EFTA countries suffered significant trade diversions as they were unable to trade with the EEC
because of the common external tariff
,Free Trade Area versus Customs Union
Why would a country join an FTA?
- There are no internal trade or tariff barriers
- There can be, however, variable foreign import tariffs set by participating member states
- Import tariffs are a tax ascribed to imported goods, that exporting suppliers pay to the
national government in which they are importing product from
- Employing an import tariff is beneficial to the importer because it helps protect domestic
goods (as in comparison domestic products will be relatively cheaper for domestic
customers), and it can also help infant domestic industries grow (as they can be free of
international competition)
Variable import tariffs means that trade will most likely be deflected through the lowest tariff country
to the highest tariff country – resulting in individuals seeking a profit: they can travel from low tariff
areas and sell for profit in high tariff areas (this is called trade deflection)
What would be needed to fix trade deflection in a FTA?
- Certificate of origin – so that import tariffs can be correctly paid between FTA borders
- High customs surveillance – of what is entering and leaving a country (to potentially be sold
elsewhere)
Why would a country join a customs union?
- Common External Tariff
- Removal of administrative and bureaucratic processes
Why would there be hesitance to join a customs union?
- It requires that sovereignty is given up when it comes to setting an import tariff
- It requires for all participating members to be somewhat politically integrated, so that
negotiations can take place over the setting of common import tariffs
Trade Creation and Trade Diversion
Joining a FTA increases international trade because of the absence of an import tariff, that may have
resulted in international partners’ products being more expensive – thus not imported this is
called trade creation
Trade diversion (sometimes referred to as supply switch) occurs when countries within an FTA import
other participating countries’ products rather than importing outside of the FTA (because although
the cost might be cheaper, the import tariff makes the purchase more expensive)
Common Agricultural Policy (CAP)
Agriculture remained outside of the trade liberalisation of the customs union – it was not open to
free trade amongst EEC members
Background CAP
1962: CAP began as a simple price support policy – in which subsidies would be given to smaller and
poorer farms meaning the more goods you could produce, the more money you could make by
selling it to the EU
,The Green Revolution and its consequences
The Green Revolution denotes the 1970s rise in agricultural efficiency (with the use of pesticides and
more efficient farming techniques) the supply in agricultural goods significantly increased after
this, resulting in overproduction
In spite of overproduction, there are still more efficient producers in agriculture outside of the EU
With the world price being relatively low, the EU must protect EU goods by raising the import tariff
so that EU consumers are more likely buy EU agricultural goods
EU farmers are generally less efficient than other global producers, so the EU set a common price
floor so that European farmers could less their produce at a standardised price to the EU for export
What EU overproduction meant for the EU budget: the EU had to sell surplus products for world
price (much lower than what they purchased it for with the farmers) whilst still paying European
farmers in the form of subsidies the EU budget began to become consumed by the payments
under the CAP
Consequences of the CAP
- Overproduction, resulting in intensive agriculture
- High prices of EU consumers
- Welfare loss
- Inefficient producers were safeguarded
- Costly – 1/3 EU budget
Lecture 2: Completion of the Single Market
The initial successes of the EEC6 Customs Union:
- Increase in intra-EU trade (resulting in trade creation)
- By 1990, 2/3 of imports came from inside of the customs union
1970s: Economic Stagnation
End of the postwar economic expansion period (1945-1973), triggered mainly by:
- The first oil crisis in 1973
- The collapse of the Bretton Woods system 1971
- High inflation
This period is coined as a decade of stagflation (stagnating economy + inflation)
The dominant economic paradigm (Keynesian economic thought) was in decline
1979: Second Oil Crisis shocked EU economy
1980s
American central bank launched anti-inflationary policy with high interest rates it made borrowing
money and investing it more expensive, which led to an US and EU recession
Unemployment crisis in the EU
, Eurosclerosis: describes a pattern of economic stagnation that results from government over-
regulation (the welfare state made the labour market inflexible to adapt to shocks)
EU economies were fragmented, there was little specialisation and economies of scale
1985: Rebirth of European Integration?
Jacques Delors became the president of the Commission (1985), seen as the driving force behind a
new wave of further EU integration
He introduced the Single European Act (1986) that established the completion of the internal market
and the Delors Report (1989) that established the EMU, and formed the basis of the Maastricht
Treaty
Completing the Internal Market
White Paper proposed by Lord Cockfield contained 300 measures to remove trade barriers with a
structured timetable
1986 Single European Act (Delors)
- Creation of an area without internal frontiers
- Followed up on the White Paper
- Sped up decision making in the Council
- Introduced the Single Market Programme (SMP) programme to remove non-tariff barriers
by 1992
Non-Tariff Barriers (NTBs)
All other trade barriers other than taxes e.g. differences in regulations and standards / border
controls etc.
Cockfield and his Commission distinguished different NTBs:
1. Physical barriers reducing border formalities
2. Technical barriers eliminating different national regulations and standards (mutual
recognition)
3. Fiscal barriers indirect taxes (e.g. VAT) / tax competition
It was hoped that these policies would lead to economic growth in these ways:
1. Reduction of economic rents less of a monopoly on power
2. Reduction of X-inefficiencies by increasing competition, efficiency in production should
increase too
3. Economics from restructuring production process is restructured because of the increase
in competition
Criticisms
- Main stream interpretation market integration is good for consumers
- However, on the other side of things, you could say that most of this economic integration
serves big businesses
- Many of Cockfield’s ideas came from lobbyists (mainly big companies in Europe)
- Completion of the internal market = “EU is an engine for neoliberalism”
