European Integration
Trade and Money

At a lunchtime meeting in Washington DC on 8 October, hosted by the Institute for International Economics, Alasdair Smith and Alberto Giovannini discussed the implications of European integration for world trade, international financial markets and economic policies in the US, Europe and Japan. Smith is Professor of Economics at the University of Sussex, a member of CEPR's Executive Committee, and formerly Co-Director of the Centre's International Trade programme. He contributed to a recent CEPR volume, European Integration: Trade and Industry. This reports work carried out in Centre's research programme on The Consequences of `1992' for International Trade, supported by the Commission of the European Communities under its SPES programme and by the UK Department of Trade and Industry and Foreign and Commonwealth Office. Giovannini is Associate Professor of Economics and Finance at the Graduate School of Business, Columbia University, a Research Fellow in the Centre's International Macroeconomics programme, and coeditor of the companion volume, European Financial Integration. This reports work carried out in CEPR's research programme on Financial and Monetary Integration in Europe, supported by the Commission of the European Communities under its SPES programme and additionally by the Ford Foundation. The views expressed by the speakers were their own, however, not those of any of the above organizations nor of CEPR, which takes no institutional policy positions.
Smith noted that the European Community's attention is now centred on progress towards political and monetary union, but the outcome of its 1992 programme will tell us whether the Community is to become `Fortress Europe' or part of a more open world trade order. Fears of EC protectionism stem largely from its Common Agricultural Policy (CAP), which harms EC consumers and non-EC farmers alike and is not even particularly beneficial for many EC farmers. Despite its economic and budgetary costs, the CAP has proved remarkably resilient, and it is now the major obstacle to completing the Uruguay Round of the GATT. Although the European Community's economic integration made an unpromising start in adopting the CAP as the first genuine Community-wide policy, it is not clear that its faults are associated with integration as such. Indeed, many non-EC European countries such as Austria, Norway and Switzerland have agricultural policies that are even more irrational and costly than the CAP.
EC member states' mutual recognition of national standards will play a critical role in achieving the 1992 programme's aims of increased competitiveness and free trade within the Community. The least demanding national standards will typically become the Community standards and will open the entire European internal market to non-Community producers that already enjoy free access to any one of its national markets. For example, imports of cars from Japan are now highly restricted in some EC member states' national markets but not in others. Simply removing all intra-EC trade barriers would at least double the present Japanese share from 10% to 20% with highly damaging consequences to European car producers. The European Commission has stepped away from such a pro-competitive policy by persuading Japan to limit its imports into the Community as a whole until the end of 1999. Although this restriction is undesirable in principle, Japanese direct investment in the European car industry will probably render it ineffective in restricting the sales of cars made by Japanese companies. Such a policy may be dangerous, however, if Japanese producers sell more `transplant' cars than the Community expects and it then seeks to renegotiate the restrictions on imports in an attempt to limit their market shares. Such an outcome would probably be illegal under the Community's own rules, and it would certainly have strongly anti-competitive effects.
Similar tensions between free trade and protectionism are present in the Community's evolving policies towards Eastern Europe. Recent research suggests that East European exports may include not only low technology, labour-intensive products, but also medium- and high-technology products. Strong sectional interests in Western Europe are already lobbying for restrictions on East European market access in agriculture, steel, metal products, food processing, textiles, clothing and consumer electronics. Smith argued, however, that denying the reforming economies access to Western markets would be a political and economic disaster: they may require aid and debt relief, but they need investment above all else. This will only become available once markets for their products become established. The EC must surely recognize its historic responsibilities: the East Europeans are now looking to the Community not just for markets, but also through association agreements and eventual membership for a framework of rules and policies to guide their own development.
Alberto Giovannini argued that the gradualist strategy for the achievement of European economic monetary union as advocated by the Delors Committee Report, which depends critically on economic convergence (in particular the convergence of national inflation rates), is unlikely to succeed. Inflation rates have not converged because policy-makers have to act on the public's expectations of prices, wages and interest rates. In France, Italy, Spain and the UK, the public is sceptical of governments' ability to reduce domestic inflation. This scepticism is compounded by general uncertainty over national governments' intentions, which can only be gauged from their actions. They have sent few and noisy signals to the market-place; without clear and unambiguous signals, convergence is unlikely to be achieved.
Assessing the likelihood that a currency union will be established in Europe before the turn of the century, Giovannini argued that recent experience in particular German reunification suggests that achieving monetary union and creating the institutions needed to sustain it require a high degree of political cohesion. To achieve monetary unification, European governments should therefore concentrate their efforts on building suitable institutions and not spend too much time worrying about economic convergence. The criteria advocated by Germany for monetary union within the European Community gradualism and inflation convergence were quickly swept under the carpet for its own monetary union in 1990.
Giovannini also noted that recent experience suggests that European governments have been much more efficient in eliminating the national rules and regulations that had previously afforded them some control over their own domestic economies than in replacing these with suitable new pan-European institutions. For example, the liberalization of capital controls has reduced national central banks' ability to determine interest rates (at given exchange rate parities) through open market operations. Similarly, the Second Banking Directive has significantly increased the mobility of banks within the EC, without at the same time eliminating the opportunities for `regulatory arbitrage'; yet there is still only limited coordination in the supervisory and regulatory activities of individual EC member countries.

European Integration: Trade and Industry, L Alan Winters and Anthony Venables (eds.),
Cambridge University Press for CEPR, £27.50/$54.50.

European Financial Integration, Alberto Giovannini and Colin Mayer (eds.),
Cambridge University Press for CEPR, £30.00/$49.50.