Economic Integration in Europe

Over the past two decades two important milestones contributed to the continued progress of the EU: the Single European Act and the Maastricht Treaty.

SINGLE EUROPEAN ACT

By the mid-1980s, EU member nations were frustrated by remaining trade barriers and a lack of harmony on several important matters, including taxation, law, and regulations. The important objective of harmonizing laws and policies was beginning to appear unachievable. A commission that was formed to analyze the potential for a common market by the end of 1992 put forth several proposals. The goal was to remove remaining barriers, increase harmonization, and thereby enhance the competitiveness of European companies. The proposals became the Single European Act (SEA) and went into effect in 1987.

As companies positioned themselves to take advantage of the opportunities that the SEA offered, a wave of mergers and acquisitions swept across Europe. Large firms combined their special understanding of European needs, capabilities, and cultures with their advantage of economies of scale. Small and medium-sized companies were encouraged through EU institutions to network with one another to offset any negative consequences resulting from, for example, changing product standards.

MAASTRICHT TREATY

Some members of the EU wanted to take European integration further still. A 1991 summit meeting of EU member nations took place in Maastricht, the Netherlands. The meeting resulted in the Maastricht Treaty, which went into effect in 1993.

The Maastricht Treaty had three aims. First, it called for banking in a single, common currency after January 1, 1999, and circulation of coins and paper currency on January 1, 2002. Second, the treaty set up monetary and fiscal targets for countries that wished to take part in monetary union. Third, the treaty called for political union of the member nations—including development of a common foreign and defense policy and common citizenship. Member countries will hold off further political integration until they gauge the success of the final stages of economic and monetary union. Let’s take a closer look at monetary union in Europe.

European Monetary Union

As stated previously, EU leaders were determined to create a single, common currency. European monetary union is the European Union plan that established its own central bank and currency in January 1999. The Maastricht Treaty stated the economic criteria with which member nations must comply to partake in the single currency, the euro. First, consumer price inflation must be below 3.2 percent and must not exceed that of the three best-performing countries by more than 1.5 percent. Second, the debt of government must be 60 percent of GDP or lower. An exception is made if the ratio is diminishing and approaching the 60 percent mark.

European monetary union

European Union plan that established its own central bank and currency.

Third, the general government deficit must be at or below 3.0 percent of GDP. An exception is made if the deficit is close to 3.0 percent or if the deviation is temporary and unusual. Fourth, interest rates on long-term government securities must not exceed, by more than 2.0 percent, those of the three countries with the lowest inflation rates. Meeting these criteria better aligned countries’ economies and paved the way for smoother policy making under a single European Central Bank. The 16 EU member nations that have adopted the single currency are Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

MANAGEMENT IMPLICATIONS OF THE EURO

The move to a single currency influences the activities of companies within the European Union. First, the euro removes financial obstacles created by the use of multiple currencies. It completely eliminates exchange-rate risk for business deals between member nations using the euro. The euro also reduces transaction costs by eliminating the cost of converting from one currency to another. In fact, the EU leadership estimates the financial gains to Europe could eventually be 0.5 percent of GDP. The efficiency of trade between participating members resembles that of interstate trade in the United States because only a single currency is involved.

Second, the euro makes prices between markets more transparent, making it difficult to charge different prices in adjoining markets. As a result, shoppers feel less of a need to travel to other countries to save money on high-ticket items. For example, shortly before monetary union a Mercedes-Benz S320 (www.mercedes.com) cost $72,614 in Germany but only $66,920 in Italy. A Renault Twingo (www.renault.com) that sold for $13,265 in France cost $11,120 in Spain. Car brokers and shopping agencies even sprang up specifically to help European consumers reap such savings. The euro has greatly reduced or eliminated this type of situation.

Enlargement of the European Union

One of the most historic events across Europe in recent memory was EU enlargement from 15 to 27 members. Croatia, Turkey, and the former Yugoslav Republic of Macedonia remain candidates for EU membership and are to become members after they meet certain demands laid down by the EU. These so-called Copenhagen Criteria require each country to demonstrate that it:

■ Has stable institutions, which guarantee democracy, the rule of law, human rights, and respect for and protection of minorities.

■ Has a functioning market economy, capable of coping with competitive pressures and market forces within the European Union.

■ Is able to assume the obligations of membership, including adherence to the aims of economic, monetary, and political union.

■ Has the ability to adopt the rules and regulations of the community, the rulings of the European Court of Justice, and the treaties.

Although it has applied for membership, negotiations for Turkey are expected to be difficult. One reason for Turkey’s lack of support in the EU is charges (fair or not) of human rights abuses with regard to its Kurdish minority. Another reason is intense opposition by Greece, Turkey’s longtime foe. Turkey does have a customs union with the EU, however, and trade between them is growing. Despite disappointment among some EU-hopefuls and despite intermittent setbacks in the enlargement process, integration is progressing. To learn a bit more about how entrepreneurs can do business in one EU country, see the Entrepreneur’s Toolkit titled, “Czech List.”

Structure of the European Union

Five EU institutions play particularly important roles in monitoring and enforcing economic and political integration (see Figure 8.2). Two other EU institutions (Ombudsman and Data Protection Supervisor) fulfill secondary and support roles and are not discussed here.

ENTREPRENEUR’S TOOLKIT Czech List

The countries of Central and Eastern Europe that belong to the EU represent a land of opportunity. But like doing business anywhere, opportunity must be balanced against the challenges of a particular location. Entrepreneurs who have succeeded in the Czech Republic offer this advice.

■ Formalities. Czech society is rather formal, and it is best to tend toward the more formal unless you know your colleague well. This includes using titles like “doctor” and “mister.” It’s rarely appropriate to use first names unless you’re close friends.

■ Business Relationships. Making money is obviously important and the ultimate goal for any business. Still, building personal relationships, establishing good references, and doing favors for others can smooth the way for newcomers.

■ Czech Partners. Being communist for 40 years before it became a capitalist democracy has left its mark on the Czech people and their culture. Finding a local partner who can handle the inevitable cultural difficulties that arise is crucial.

■ Local Professionals. It is a good idea to hire a Czech accountant or someone familiar with Czech laws, taxes (including a VAT tax of 19 percent), and red tape. An attorney who is bilingual can also interpret differences between Czech and U.S. laws.

■ Who’s in Charge. Companies need a “responsible person” (or jednatel in Czech) who is in charge of all aspects of the business. Some Czechs still feel more comfortable working with this jednatel rather than unfamiliar company reps.

Source: “Online Business Guide to the Czech Republic,” Price-waterhouseCoopers Web site (www.pwc.com/cz/eng/ins-sol/spec-int/taxguide), select reports; Czech Republic Web site (www.czech.cz), select reports; Moira Allen, “Czech List: Doing Business with Eastern Europe,” Entrepreneur Magazine (www.entrepreneur.com), July 2000.

FIGURE 8.2 Institutions of the European Union

EUROPEAN PARLIAMENT

The European Parliament consists of nearly 800 members elected by popular vote within each member nation every five years. As such, they are expected to voice their particular political views on EU matters. The European Parliament fulfills its role of adopting EU law by debating and amending legislation proposed by the European Commission. It exercises political supervision over all EU institutions—giving it the power to supervise commissioner appointments and to censure the commission. It also has veto power over some laws (including the annual budget of the EU). There is a call for increased democratization within the EU, and some believe this could be achieved by strengthening the powers of the Parliament. The Parliament conducts its activities in Belgium (in the city Brussels), France (in the city Strasbourg), and Luxembourg.

COUNCIL OF THE EUROPEAN UNION

The council is the legislative body of the EU. When it meets it brings together representatives of member states at the ministerial level. The makeup of the council changes depending on the topic under discussion. For example, when the topic is agriculture, the council is composed of the ministers of agriculture from each member nation. No proposed legislation becomes EU law unless the council votes it into law. Although passage into law for sensitive issues such as immigration and taxation still requires a unanimous vote, some legislation today requires only a simple majority to win approval. The council also concludes, on behalf of the EU, international agreements with other nations or international organizations. The council is headquartered in Brussels, Belgium.

EUROPEAN COMMISSION

The commission is the executive body of the EU. It comprises commissioners appointed by each member country—larger nations get two commissioners, smaller countries get one. Member nations appoint the president and commissioners after being approved by the European Parliament. It has the right to draft legislation, is responsible for managing and implementing policy, and monitors member nations’ implementation of, and compliance with, EU law. Each commissioner is assigned a specific policy area, such as competitive policy or agricultural policy. Although commissioners are appointed by their national governments, they are expected to behave in the best interest of the EU as a whole, not in the interest of their own country. The European Commission is headquartered in Brussels, Belgium.

COURT OF JUSTICE

The Court of Justice is the court of appeals of the EU and is composed of 27 judges (one from each member nation) and eight advocates general who hold renewable six-year terms. One type of case that the Court of Justice hears is one in which a member nation is accused of not meeting its treaty obligations. Another type is one in which the commission or council is charged with failing to live up to their responsibilities under the terms of a treaty. Like the commissioners, justices are required to act in the interest of the EU as a whole, not in the interest of their own countries. The Court of Justice is located in Luxembourg.

Romania’s president (left) and prime minister point to their country on a map of Europe during a welcoming ceremony for Bulgaria and Romania to the European Union. The EU grew from a grouping of just six nations to include 27 members today. To balance divergent national interests, the EU created a unique system of government and designed the role of each EU institution to reflect this balancing act.

Source: Nicolas Bouvy/CORBIS-NY.

COURT OF AUDITORS

The Court of Auditors comprises 27 members (one from each member nation) appointed for renewable six-year terms. The court is assigned the duty of auditing the EU accounts and implementing its budget. It also aims to improve financial management in the EU and report to member nations’ citizens on the use of public funds. As such, it issues annual reports and statements on implementation of the EU budget. The court has roughly 800 auditors and additional staff to assist it in carrying out its functions. The Court of Auditors is based in Luxembourg.

European Free Trade Association (EFTA)

Certain nations in Europe were reluctant to join in the ambitious goals of the EU, fearing destructive rivalries and a loss of national sovereignty. Some of these nations did not want to be part of a common market but instead wanted the benefits of a free trade area. So in 1960 several countries banded together and formed the European Free Trade Association (EFTA) to focus on trade in industrial, not consumer, goods. Because some of the original members joined the EU and some new members joined EFTA (www.efta.int), today the group consists of only Iceland, Liechtenstein, Norway, and Switzerland (see Map 8.2).

The population of EFTA is around 12.5 million, and it has a combined GDP of around $707 billion. Despite its relatively small size, members remain committed to free trade principles and raising standards of living for their people. The EFTA and EU created the European Economic Area (EEA) to cooperate on matters such as the free movement of goods, persons, services, and capital among member nations. The two groups also cooperate in other areas, including the environment, social policy, and education.

Quick Study

1. Why did Europe initially desire to form a regional trading bloc?

2. Describe the evolution of the European Union. What are its five primary institutions?

3. What is European monetary union? Explain its importance to business in Europe.

4. Briefly describe the European Free Trade Association.

Integration in the Americas

Europe’s success at economic integration caused other nations to consider the benefits of forming their own regional trading blocs. Latin American countries began forming regional trading arrangements in the early 1960s, but they made substantial progress only in the 1980s and 1990s. North America was about three decades behind Europe in taking major steps toward economic integration. Let’s now explore the major efforts toward economic integration in North, South, and Central America, beginning with North America.

North American Free Trade Agreement (NAFTA)

There has always been a good deal of trade between Canada and the United States. Canada and the United States had in the past established trade agreements in several industrial sectors of their economies, including automotive products. In January 1989 the U.S.–Canada Free Trade Agreement went into effect. The goal was to eliminate all tariffs on bilateral trade between Canada and the United States by 1998.

Accelerating integration in Europe caused new urgency in the task of creating a North American trading bloc that included Mexico. Mexico joined what is now the World Trade Organization in 1987 and began privatizing state-owned enterprises in 1988. Talks among Canada, Mexico, and the United States in 1991 eventually resulted in the formation of the North American Free Trade Agreement (NAFTA). NAFTA (www.nafta-sec-alena.org) became effective in January 1994 and superseded the U.S.–Canada Free Trade Agreement. Today NAFTA comprises a market with 445 million consumers and a GDP of around $16 trillion (see Map 8.1).

As a free trade agreement, NAFTA seeks to eliminate all tariffs and nontariff trade barriers on goods originating from within North America. The agreement also calls for liberalized rules regarding government procurement practices, the granting of subsidies, and the imposition of countervailing duties (see Chapter 6). Other provisions deal with issues such as trade in services, intellectual property rights, and standards of health, safety, and the environment.

Local Content Requirements and Rules of Origin

While NAFTA encourages free trade among Canada, Mexico, and the United States, manufacturers and distributors must abide by local content requirements and rules of origin. Although producers and distributors rarely know the precise origin of every part or component in a piece of industrial equipment, they are responsible for determining whether a product has sufficient North American content to qualify for tariff-free status. The producer or distributor must also provide a NAFTA “certificate of origin” to an importer to claim an exemption from tariffs. Four criteria determine whether a good meets NAFTA rules of origin:

■ Goods wholly produced or obtained in the NAFTA region

■ Goods containing non-originating inputs but meeting Annex 401 origin rules (which covers regional input)

■ Goods produced in the NAFTA region wholly from originating materials

■ Unassembled goods and goods classified in the same harmonized system category as their parts that do not meet Annex 401 rules but have sufficient North American regional value content

Effects of NAFTA

Since NAFTA went into effect, trade among the three nations has increased markedly, with the greatest gains occurring between Mexico and the United States. Today the United States exports more to Mexico than it does to Britain, France, Germany, and Italy combined. In fact, in 1997 Mexico became the second largest export market for the United States for the first time ever. Since then, however, China has taken over second place and bumped Mexico to third place in terms of exports to the United States.

Overall, NAFTA helped trade among the three countries to grow from $297 billion in 1993 to nearly $930 billion in 2007.6 Since the start of NAFTA, Mexico’s exports to the United States jumped an astonishing 275 percent, to around $150 billion, and U.S. exports to Mexico grew 170 percent, to more than $111 billion.7 As these numbers suggest, the United States has developed a trade deficit with Mexico.8 Over the same period, Canada’s exports to the United States more than doubled to nearly $300 billion, while U.S. exports to Canada grew 76 percent, to $176 billion. Canada exported very little to Mexico before NAFTA, but afterward exports grew more than threefold, to nearly $2.7 billion.9

The agreement’s effect on employment and wages is not as easy to determine. The U.S. Trade Representative Office claims that exports to Mexico and Canada support 2.9 million U.S. jobs (900,000 more than in 1993), which pay 13 to 18 percent more than national averages for production workers.10 But the AFL-CIO group of unions dispute this claim; they argue that since its formation, NAFTA has cost the United States over one million jobs and job opportunities.11

In addition to claims of job losses, opponents claim that NAFTA has damaged the environment, particularly along the United States–Mexico border. Although the agreement included provisions for environmental protection, Mexico is finding it difficult to deal with the environmental impact of greater economic activity. But Mexico’s Instituto Nacional de Ecologia (www.ine.gob.mx) has developed an industrial-waste-management program, including an incentive system to encourage waste reduction and recycling. The U.S. and Mexican federal governments have invested several billion dollars in environmental protection efforts since the creation of NAFTA.12

Expansion of NAFTA

Continued ambivalence among union leaders and environmental watchdogs regarding the long-term effects of NAFTA is delaying its expansion. The pace at which NAFTA expands will depend to a large extent on whether the U.S. Congress grants successive U.S. presidents trade-promotion (“fast track”) authority. Trade-promotion authority allows a U.S. administration to engage in all necessary talks surrounding a trade deal without the official involvement of Congress. After details of the deal are decided, Congress then simply votes yes or no on the deal and cannot revise the treaty’s provisions.

But there is little doubt that integration will expand some day in the Americas. In fact, it is even possible that the North American economies will one day adopt a single currency. As trade among Canada, Mexico, and the United States strengthens, a single currency (most likely the U.S. dollar) would benefit companies in these countries with reduced exposure to changes in exchange rates. Although this would be difficult for Canada and Mexico to accept politically, in the long run we could see one currency for all of North America. Ecuador, in fact, has already “dollarized” its economy.

Central American Free Trade Agreement (CAFTA-DR)

The potential benefits from freer trade induced another trading bloc between the United States and six far smaller economies. The Central American Free Trade Agreement (CAFTA-DR) was established in 2006 between the United States and Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and later the Dominican Republic.

Prior to its creation, CAFTA-DR nations had already traded a great deal. The Central American nations and the Dominican Republic are already the second-largest U.S. export market in Latin America behind Mexico. The CAFTA-DR nations represent a U.S. export market larger than India, Indonesia, and Russia combined. Likewise, nearly 80 percent of exports from the Central American nations and the Dominican Republic already enter the United States tariff-free. And Central American nations have already cut average tariffs from 45 percent in 1985 to around 7 percent today. The combined value of goods traded between the United States and the six other CAFTA-DR countries is around $32 billion.13

The agreement benefits the United States in several ways. CAFTA-DR aims to reduce tariff and nontariff barriers against U.S. exports to the region. It also ensures that U.S. companies are not disadvantaged by Central American nations’ trade agreements with Mexico, Canada, and other countries. The agreement also requires the Central American nations and the Dominican Republic to reform their legal and business environments to encourage competition and investment, protect intellectual property rights, and promote transparency and the rule of law. CAFTA-DR is also designed to support U.S. national security interests by advancing regional integration, peace, and stability.

A tractor pulls several trailers of picked pineapples on a farm in La Virgen, Costa Rica. Like any free trade agreement, CAFTADR has supporters and detractors. Supporters say that the agreement will encourage trade efficiency and promote investment that will bring good-paying jobs to the region. Yet others fear the agreement will benefit large U.S. companies and badly damage small businesses and farmers across Central America.

Source: John Coletti/JAI/CORBISNY.

Quick Study

1. What was the impetus for the formation of the North American Free Trade Agreement?

2. What effect has NAFTA had on trade among its member nations?

3. List the main benefits the United States obtains from the Central American Free Trade Agreement.