Economic Growth and Development:

A 20th Century Perspective

Lecture 3
The European framework

Dr Matthias Morys
 Outline of today’s lecture

• Introduction

• Are the reasons behind European integration

of political or of economic nature?

• Why did Britain not join in 1958?

• Trade integration
 European Union - I
Unique example of economic integration
• deeper than NAFTA (US, Canada, Mexico), Mercosur (Brazil, Argentina, Uruguay,
Paraguay)
• customs union rather than free trade area
• not limited to trade integration
(a) free movement of factors of production, ie capital and labour
(b) currency union (EMU)
(c) aims at regional convergence
(d) supranational institutions to enforce EU law
(European Court of Justice, European Commission)
NB: EU law often genuinely created by European Court of Justice
• European Commission: particularly active in competition policy

Some parts of further integration are inevitable if economic conditions are ripe
(in particular: Euro; opt-out clause secured only by UK, Denmark, Sweden)
 European Union - II
Different from earlier forms of economic integration
• 19th century economic integration often informal (epitomised by gold standard) or bilateral
(trade treaties, eg Cobden-Chevalier English-French free trade agreement of 1860; 19 th
century invention of the most-favoured nation clause as the begin of multilateral trade
treaties?)

Why is late 20th century economic integration different from the late 19 th century?
• overlap between economic and political factors

• world had not yet experienced the globalization backlash of the interwar period
• 19th century belief: trade liberalisations are irreversible as they are mutually beneficial
• This belief was shattered in the 1930s: protectionist policies even of the UK
• competitive devaluations (cf. Eichengreen&Sachs 1985) and imposition of capital controls
• Contemporaries – and those were the policy-makers of the post-WW II period – aware of
conflict between short-term gains and long-term pains and individual rationality versus
collective irrationality: 1936 Tripartite Agreement
•  multilateral framework as a commitment device
 European Union - III
• 75% of the output is produced by 5 member countries only
(Germany, UK, France, Italy, Spain)
• 10 members produce less than 1% each of total output; 9 from
these 10 members joined in 2005
• leads to significant over-representation of small countries in the
EU institutions:
(a) Council of the EU
(b) European Commission
(c) European Parliament (here less pronounced)
(d) European Court of Justice
(e) Governing Council of the European System of
Central Banks (ESCB)
 European Union - IV
Founding members
• 1958: France, West Germany, Italy, Netherlands, Belgium, Luxembourg
“Correcting two initial errors”
• 1973: United Kingdom, Ireland, Denmark
Southern European “new” democracies
• 1981: Greece
• 1986: Spain, Portugal
Collapse of Soviet communism I
• 1995: Austria, Finland, Sweden
• 2005: Poland, Czech Republic, Slovakia, Hungary, Lithuania, Latvia,
Estonia, Slovenia, Cyprus, Malta
Collapse of Soviet communism II
• 2007: Romania, Bulgaria
• 2013: Croatia
Are the reasons behind European integration
of political or of economic nature?
Political reasons
• to prevent another war in Europe / containment of
Germany (1951: European Community of Steal and Coal 
supranational control of strategically important industries)
• Germany, Italy: reintegration after WW II
• bulwark against Soviet communism
• Europe as a whole would have greater political power
• economic integration as the only feasible form of
integration (European Defence Force fails in 1954)
• “spread of democracy”: important since 1981
Are the reasons behind European integration
of political or of economic nature? (cont.)
Economic reasons
• multilateral system needed to restore free trade and prevent another
“globalization backlash” as in the interwar period
• agricultural surpluses of the early 1950s: France, Netherlands (and
Denmark!)
• German export industry
• US: benefits of free trade vs. benefits of infant industry protection
(Abramovitz 1986: European productivity levels in 1950 at 50% US level) 
EU as happy medium (free trade internally, protection against overly
competitive US externally)
• Similarly cautious approach was followed in the exchange-rate
recommendations (European Payments Union: clearing union among
European countries but no free convertibility with US)
 What explains the different approach in the 1990s?
 Why did Britain not join in 1958?
• little importance of trade with EU-6 (ca. 20%)
• no interest in Common Agricultural Policy
exports to EU-6 labour force in
agriculture

France 39% 28%

West Germany 40% 22%
Italy 40% 45%
Netherlands 61% 14%
Belgium/ 61% 10%
Luxemburg

UK 23% 5%
Denmark 57% 25%
 Why did Britain not join in 1958?
Later, PM Macmillan (1956-63) applies for membership, but
vetoed by de Gaulle; EU entry only under PM Heath (1970-74)

What can we learn from the initial UK resistance about the

motivations of the other 6 countries?
• Milward infers that economic motivations were of paramount
importance; if those were not fulfilled, countries – such as the
UK – did not join
• overlap of political and economic motivations
• “commitment mechanism” argument can relate both to
economic and political goals
 Trade integration
Global trade patterns can only be understood if regional integration is taken into account
(North America, Europe control 2/3 of world trade; 40% of global trade within regional
integration)

History
• Trade integration has been the single most important policy of the EU. The common
market was, however, achieved in a rather lengthy fashion (35 years!):
• 1958: Treaty of Rome sets the goal
• 1968: removal of internal customs duties and introduction of common external tariff
completed
• 1987: Single European Act aims at completing the common market by 1992 (removal of
non-tariff barriers; free movement of capital)
• 1992: completion of common market

EU as a customs union
• (a) internally: no tariffs
• (b) externally: common external tariff
• ( single EU membership in the WTO)
• ( EFTA/NAFTA as free trade areas: no common external tariff)
 Trade integration (cont.)
Average annual percentage change of trade with EU
1960s 1970s

France 11.7% 17.8%

West Germany 11.4% 16.3%
Italy 12.2% 17.0%
Netherlands 11.4% 15.2%
Belgium/Luxemburg 11.1% 16.3%

UK 5.5% 14.7%
Denmark 9.3% 12.4%
 Trade integration (cont.)
Intra-European trade as percentage of total trade
1960 2001

France 39% 58%

Germany 40% 53%
Italy 40% 51%
Netherlands 61% 76%
Belgium/ 61% 75%
Luxemburg

UK 23% 54%
Denmark 57% 59%
 Trade integration (cont.)
 trade creation (= due to tariff liberalization with EU
members) much more important than trade diversion (=
due to tariff discrimination with respect to countries
outside the common external tariff)

Why have studies failed to show trade diversion?

• global trade boom after WW II because of
• strong world economy (Golden Age 1950-1973)
• liberalization within GATT/WTO coincided with
liberalization within the EU
 Trade integration (cont.)
Old trade theory (Ricardo):
• based on perfect competition & constant returns to scale
• trade happens because of differences in comparative advantages: eg, labour- vs. capital-
intensive goods
• inter-industry trade
New trade theory (Krugman):
• based on imperfect competition & increasing returns to scale
• trade happens because bigger markets allow for product differentiation and the exploitation of
economies of scale
• main effect of trade: competition effect
• ( importance of EU: prohibition of state aid + competition policy against collusion)
• intra-industry trade
NB: intra-industry trade far outstrips inter-industry trade in the EU
• Some evidence of increased competition due to Single Market Programme (C. Allen et al. 1998)
• intra-European share of world M&A increased from 10% before the Single Market to 29%
thereafter
• increased concentration: from 20% to 23%
• price-cost margins fell by 4%
• smaller economies experienced a larger gain