Home - Nytt - Index A till Ö - EMU-skeptiker - Statsvetare - Den bästa EMU-boken

Fortress Europe
Why customs unions lead to economic decline
by Henri Lepage

From The European Journal

There has been a resurgence of protectionist demands from vested interest groups during the last few months. France in particular has established itself as the leading player in the anti-globalisation campaign. I believe that the reasons for this are relatively straightforward and stem directly from the way the EU organises its international trade.

To understand this, it is useful to recall that regional trade agreements can be divided into two rough categories: free trade agreements, such as NAFTA, and customs unions, such as the European Union.

Members of a free trade area typically maintain their own tariffs on goods originating outside the area, whereas members of a customs union establish a common tariff on goods originating from non-member states.

Crucially, the establishment of common external tariffs usually commits customs unions to setting up common political and administrative institutions.

This is at the root of our current problems.

Economists like to ponder the pros and cons of pursuing a regional approach to trade liberalisation in addition to a multilateral approach (such as through the World Trade Organisation.)

Given the smaller number of players involved, regional trade agreements often help promote trade liberalisation at a faster pace than may be possible at the multilateral level. They also provide impetus for those outside the agreement to work towards multilateral reforms so that they are not left behind other countries that take advantage of freer trade with regional partners.

Though free trade agreements are generally viewed as more trade friendly than customs unions, this need not always be the case.

The European common market in its original incarnation was a powerful engine not only for liberalising trade and bringing more business competition within Europe, but also for forcing some member countries to reduce the grip of government over industry. This was especially the case in statist France.

Even socialist governments finally could do nothing else but submit themselves to the will of Brussels and to the European Court of justice's power to sue and fine national governments. The single market helped deregulate state monopolies and allowed for increased competition in regulated industries.

Similarly, regional trade agreements are generally understood to provide more benefits than costs if they are 'trade creating', rather than 'trade diverting'.

Trade diversion as defined by economists occurs when preferential treatment causes a country to replace imports from the rest of the world with imports from a free trade association member country.

The same analysis also applies to international investment decisions. Economic theory teaches that trade diversion is more likely to occur with customs unions than with free trade agreements.

Yet, though intra-European trade grew much faster than trade with regions outside the EU, most studies show that over the last few decades more trade was created in total than was lost; on balance the Single Market was a success.

Unfortunately, this may no longer be the case. I believe that once a customs union is accompanied by the creation of common political institutions, a day unavoidably comes when it falls into the trap of a 'fortress' mentality.

Since a customs union requires the existence of common political institutions, problems will usually start once tariffs and quantitative obstacles to trade have been reduced to zero.

At first, all seems well. Differences in taxes and regulations become a major factor influencing intra-zone business competition. Corporations tend to move to member countries with the most favourable tax and regulatory structures. The consequence of a successful customs union is thus to introduce competition between legal systems.

But like all producers, bureaucrats particularly those from countries with the highest tax rates and regulatory burden - do not like competition. When businesses move towards lower tax areas, governments lose revenue and their capacity to spend is reduced.

Heavy spenders feel threatened and bureaucrats lose much of their power to influence the distribution of economic rents. Thus a new discourse sets in denouncing the danger of a 'race to the bottom and the threat that unbridled competition poses to the future of modern welfare systems.

The call is invariably for a level playing field implying that people should pay the same taxes and bear the same welfare cost burden everywhere. The political priorities of the customs union - in our case the EU progressively shift from free trade to creating the conditions for fairer trade.

While still loudly emphasising the gains brought about by a more competitive economy, politicians call for the unification and harmonisation of the rules of the competitive game - not exactly the same thing. Their claim is joined and supported by short-sighted business lobbies for whom it is less costly to fall prey to political correctness than to vocally endorse a public spending reduction agenda.

This is exactly the story of the European Union. A big change occurred following the Maastricht Treaty in 1991 and its implementation over the following years. The emphasis moved from increasing market competition through lowering quantitative obstacles to trade to 'organising' competition through common policies and harmonised regulations.

A paradigm shift occurred that led to the displacement of the 'one market agenda engraved in the 1986 Single European Act, which was intended to be completed in 1992. What took its place was a new 'Level-playing-field' philosophy for which economic integration implies not only the absence of physical obstacles to trade within the EU, but also the enforcement of unified rules, standards and taxes by a stronger central European government.

As Pascal Salin, a professor of economics at the University of Paris-Dauphine, has masterfully explained, fair trade does not require competitors to pay identical taxes, or to bear the same amount of welfare contributions.'

Why not ask for the flattening down of hills and mountains they increase the costs of companies located in Alpine areas relative to those of their competitors located in flat lands? Is it not unfair they should incur higher transport costs due to an accident of geography?

Why not ask Spanish tomato growers to compensate Dutch farmers for the lack of sunshine in the Netherlands? After all, are not free heating and lighting unfair commercial advantages?

The legal and tax environment is part of the comparative advantages or disadvantages enjoyed by national businesses. The imposition of a uniform legislation all throughout the European Union may seem 'fair' to those who have more difficulties to withstand the competition from foreign products because they pay higher taxes or are subjected to tighter regulations. But it is surely 'unfair' to companies located in low-tax countries deprived of the local competitive advantage they previously enjoyed.

Under the guise of equalising competitive conditions all over the Union, the Maastricht Treaty deeply altered the nature of the Common Market. It transformed Europe into a cartel of states built around a set of common policies. The intra-European competitive process was reduced and market penetration by foreign companies was made more difficult than it would have been bad the EU stuck to the original 1986 Single European Act.

The Maastricht compromise thus made European institutions and politics much more prone to a 'fortress' mentality. Those who already long ago feared that the natural outcome of a customs union process would be to divert trade liberalisation efforts towards the formation of rival regional trade blocks are being proved right.

This fortress mentality was made even worse as a natural consequence of the launch of the euro on 1 January 1999. Economic and Monetary Union deprives profligate governments of one important means for compensating their mistakes and bad policies - they no longer control a currency which they can inflate away to pay their way.

The only way individual nation states can raise funds is through the use of taxation. Differences in taxes and legislation hence have more bearing than ever on the competitive position of economic actors.

As a consequence the public and private national interests pushing for a European neo-protectionist policy have become even more vocal.

BUT THE STORY DOES NOT STOP HERE either. If managed trade among fifteen of the richest countries in the world is fairer and morally superior to unbridled laissez-faire, why stop at fifteen?

Why not extend the cartel to twenty, to fifty, to the whole world?

The urge to do so is all the greater since the Information Technology revolution is simultaneously reducing the ability of governments to raise revenues.

The temptation to extend managed trade to the whole world is at the root of the recent crackdown of European authorities against places such as Liechtenstein, Monaco, Andorra, the Isle of Man and even the Vatican.

Recent reports have depicted these tiny 'offshore' countries as "rogue entities catering to those with assets to hide, either from the law or from the tax collector at home".' Their tradition of banking secrecy is targeted as being "a contradiction to the integration of markets" standing in the way of achieving the European goal of a single market, a single currency, and a single set of taxation and banking laws.

The Maastricht Treaty deeply altered the nature of the Common Market. It transformed Europe into a cartel of states built around a set of common policies

The OECD goes even further. One of its recent documents not only focuses on 'preferential tax regimes' in OECD nations and calls for their elimination, but also warns tax-havens that they will face sanctions if they do not acquiesce to various demands from high-tax nations.

The threat was renewed by France's finance minister, Laurent Fabius, in July 2000, when he invoked possible "penalties against territories fuelled by financial crime".'

"Globalisation is under assault," argues Daniel j. Mitchell from the Heritage Foundation in Washington, DC.' "Fearful that international competition will make costly welfare states unsustainable, politicians from industrial countries are diligently working to set up a cartel of high-tax nations. The latest gambit from the high taxers is a breathtakingly brash effort to compel low-tax nations to act as collectors for their more greedy brethren."

He adds that "the OECD has decided to resuscitate imperialism. In a startling move that tramples on sovereignty and makes a mockery of international law, the OECD is trying to force low-tax regimes to collect t taxes for confiscatory regimes."

If the OECD succeeds, international investment will suffer and world-wide growth will slow since low-tax regimes play an important role in the world economy. Institutional competition tends to keep tax burdens lower and encourages a more efficient use of public funds.

Almost every nation in the world was forced to lower income tax rates after US President Ronald Reagan slashed marginal rates in the 1980s. This happened not because the politicians of these other nations actually wanted to cut tax rates, but because the pressure to attract and retain capital, jobs and entrepreneurs forced them to adopt better policies. Is this what they want to prevent from happening again?

There are many outside Europe and notably in Latin America - who still believe that the EU is a customs union success story to be emulated. Keith Marsden, an international economist and regular contributor to the European Journal, recently demonstrated just how wide off the mark these pundits actually are.

In a study released on the very day US Senator Phil Gramm visited London to invite his British hosts to join the North American Free Trade Association "as a way of breaking up regional trade blocks and moving toward global free trade", Mr Marsden demolished the case for the 'European model'.'

He showed that NAFTAs average per capita GDP of $27,040 in 1999 was 20% higher than that of Euroland. In addition, NAFTA's average annual rate of growth of 3,6% of GDP over the last seven years to 1999 was exactly twice that of Euroland. NAFTA is also more open to international trade.

Nearly 60% of the free trade areas merchandise imports came from non-NAFTA countries whereas only 37% of Euroland's did. And NAFTA's merchandise imports are growing at twice the rate of the EU's. The number of jobs created during the same period confirms NAFTA's superiority. Employment is up by 38% in Mexico, 13% in Canada and the US, compared with only 3% in Euroland and 6% in the UK.

Workers in NAFTA countries also earn more and are taxed less than those in Euroland. A single worker with no children on an average production wage has a net income of $20,388 in the US compared to just $16,577 in Germany. For a couple with two wage earners (one on average wages, one receiving two-thirds the average wage), the figures are $35,151 and $31,199 respectively. Finally, NAFTA relies far less

More by Henri Lepage

Början på sidan

Tillbaka till startsidan