European Union has step-by-step travelled from sectoral free trade area to comprehensive free trade area, customs union to common market to economic and monetary union to near political union after Winston Churchill called for ‘United States of Europe’ in 1946. As a first step towards integration, in 1951 six countries (viz., Belgium, France, West Germany, Italy, Luxemburg, and the Netherlands) signed the Treaty of Paris to establish the European Coal and Steel Community (ECSC).
It required abolition of import duties on imports from rest of the world, and coordination of national policies with regard to subsidies to domestic coal and steel industries within ECSC. Coal and Steel trade within ECSC grew by 129% in the first five years of the Treaty.
The success of the ECSC led to attempts at integration in political and military areas (the European Defence Community and European Political Community). But these efforts could not succeed since the French Parliament turned them down in 1954. In 1957, the six members if ECSC signed the Treaty of Rome for the creation of a European Economic Community (a single, integrated market for goods, services, labor, and capital, i.e., a common market) and a European Atomic Energy Community called Euratom (to jointly develop nuclear energy for peaceful purposes).
The tariff reductions began in 1959. In 1960, seven European countries (Austria, Denmark, Norway, Portugal, Sweden, Switzerland, and UK) signed Stockholm Convention to establish the European Free Trade Association within EEC. The EEC established a Common Agricultural Policy (to stabilize food production in Europe and to guarantee a decent living for European farmers).
In 1965 a treaty was signed to merge ECSC, Euratom and the EEC, which came into being in 1967. In 1967, all remaining internal tariffs were removed and external tariffs were imposed. Thus, an FTA became a customs union. The name of EEC was changed to European Community (EC).
In the next two decades many more countries joined the EC (Denmark, Ireland and the UK in 1973, ‘Greece in 1981, Spain and Portugal in 1986, and Austria, Finland, and Sweden in 1995). Two major events took place in the late 1970s were formation of the European Parliament and the creation of European Monetary System (EMS). The EFTA lost its role to EEC. As the EEC took more responsibilities of social and political nature, the name of EEC was changed to European Community.
IN 1979, the members of EEC began to link their currencies in order to prevent radical fluctuations in currency values. The objective to create an environment in which trade and investment throughout the EC was determined by considerations of comparative advantage and efficient resource allocation rather than by changes in exchange rates.
Consequently, the European Monetary System (EMS) with its exchange rate mechanism (ERM) was brought into force. The formation of EMS was to pave the way for the eventual introduction of a single currency. EMS was designed to prevent extreme currency fluctuations by tying each currency’s value to the weighted average of the others.
The group average, the European Currency Unit (ECU) was used as a unit of account, but not in actual day-to-day transactions. The ERM prescribed an exchange rate band. Each currency in the band was allowed to fluctuate initially to ± 2.25% and to ± 15% after the 1992 crisis. ERM has effectively linked EC exchange rates to each other; the EC nations gave a large measure of independence in their monetary policies.
In 1987, the twelve members of the EC decided to go for an ambitious plan to capture additional gains from trade. The members signed the Single European Act (SEA) in 1986, which came into force in 1987. The Act was based on the Delors Report – “Completing the Internal Market”. The target date for implementation of SEA was 31 December, 1992. By that time it was expected that the “4 Freedoms” (Freedom of movement of goods, services, capital and labor) would be instituted and the EC would be at the common market level of economic integration. The key changes stipulated were:
i. Elimination of physical barriers such as tariff barriers (a single check point), cabotage, and passport between members, thereby abolishing delays and reducing resources required for complying with trade bureaucracy;
ii. Elimination of technical barriers such as differences in product, safety and standards, as part of mutual recognition principle;
iii. Elimination of fiscal barriers, such as differences in taxes, subsidies, and public procurement to bring down the cost; and
iv. Elimination of regulatory barriers, such as licences required in each country, and different codes relating to company law to increase competition despite the widest possible support.
Despite the widest possible support, the implementation of Single European Market has not been without obstacles. These have been:
i. Restructuring Effects:
Conversion of a closed national economy to open economy is associated with restructuring. The less efficient firms go out of business and efficient ones grow. Firms, labor unions, communities and regions adversely affected fight to prevent full implementation of the SEA. The auto industry is the best example of an economic interest that fought to prevent the full realisation of the goals of SEA.
To address the problem of structural reforms there were programmes being funded by EC and the national governments. Many economists and politicians argue that the social safety nets generosity creates its own problems.
It was this reason that unemployment rates were so high in late 1980s and 1990s. Such generosity reduced the cost of unemployment and incentive to look for work. In addition, the burden for such programs falls upon the employers and many firms feel reluctant to hire new employees during an expansion.
ii. Harmonisation of Technical Standards:
In order to realize the complete integration, there were 100,000 technical standards (from building codes, to industrial equipment, to consumer safety, to health standards, to university degrees, and job qualifications) requiring harmonisation. Many of which were reflections of cultural identities. But it leads to problem of multiple product certifications.
iii. Value-Added Taxes (Vat):
Value-added taxes are essentially sales taxes. These ranged from 19 to 35% of the total revenues of member nations total government revenues. The rates of VAT varied from 12% (Luxemburg and Spain) to 25% (Ireland). The inability to agree on harmonisation of VAT was another obstacle. Though minimum and maximum rates were fixed at 15 and 25%. But a difference of more than 5% leads to cross border purchases and loss of revenue to higher VAT rate country.
iv. Public Procurement:
Most nations of the world discriminate in favor of nationally owned suppliers for purchase by governments or government-owned enterprises. Though attempt has been made to eliminate the discrimination but this has proved to be difficult. This leads to limit the benefits of restructuring and the gains from trade.
Excitement of SEA and several years of economic integration as envisaged in the Delors Report, rapid pace of German unification, collapse of Soviet Block, necessity to have a single currency as a result of changes occurred under the SEA, the EC leaders of 12 nations signed the Maastricht Treaty in December 1991, following the ratification of the treaty by member states in 1993, the name of EC was changed to European Union (EU).
The Treaty had two goals – political union and monetary union. The vision of political union brought up a number of issues, viz., a common European citizenship; joint foreign, defence, immigration, and policing policies; and common social charter concerning working conditions and employees’ rights. The Treaty granted veto power to European Parliament over new national laws.
Also to be noted is that the EU has also accepted the principle of subsidiarity that the EU should intervene only in areas of common concern and that most policies be set at the national level. Similarly, all member countries have not accepted all the points in the Treaty.