EC-EFTA relations received a major push in 1984, when the EC and EFTA jointly issued the Luxembourg Declaration aimed at creating a dynamic European Economic Space (EES) and signaling the political will to extend cooperation beyond the FTAs. Relations developed a new sense of urgency—particularly on the EFTA side—following the EC Commission’s issuance of its White Paper, Completing the Internal Market, in 1985, and adoption of the Single European Act in 1986. As the internal market program gained momentum, the EFTA countries grew increasingly concerned about being left out.
In January 1989, efforts to improve cooperation gained new momentum from an invitation to the EFTA by Jacques Delors, President of the EC Commission, to form a more structured relationship with the EC. The EFTA responded in March 1989 with the so-called Oslo Declaration, in which EFTA heads of state expressed their willingness to explore the “ways and means to achieve a more structured partnership….” This put the EES negotiations on a two-track course. The legal and institutional changes required by greater cooperation were to be covered under the so-called Oslo-Brussels process, while issues related to laying the basis for the free movement of goods, services, capital, and labor within Western Europe—the four freedoms—continued to be addressed in the follow-up to the Luxembourg Declaration. Since launching the Oslo-Brussels process, the EFTA’s relationship with the EC has changed considerably as the EFTA has sought to present a more united front. Ministers from EC and EFTA countries agreed in December 1989 to begin formal negotiations on forming a more structured relationship and began negotiating in June 1990. While the EES appears to be gaining momentum, the possibility of little or no change in EC-EFTA relations cannot be excluded.
The success of the EES hinges on progress on a number of legal and institutional issues. Under any circumstances, relations could benefit from improved mutual recognition in civil and commercial law. Both organizations have made internal progress in this area, but only half of the countries have signed a multilateral accord on the subject.
The EFTA countries have also expressed a desire to have a say in the EC’s decision-making process on legislation and other issues that also affect the EES. The EC has repeatedly said that, while it would allow the EFTA countries to voice their opinions, it would not allow them to vote, a right reserved only for EC member states. The EFTA has accepted that EES legislation will be largely based on EC law. However, it is still seeking a genuine joint decision-making mechanism on matters relating to the EES. Beyond this, the EES implies the creation of new institutions for judicial monitoring and enforcement, both in the EFTA and in a joint EC-EFTA body. It would require the EFTA to create a judicial body of its own with enforcement powers over its members. While a joint judicial body would also appear desirable to handle inter-bloc disputes, the EC may resist this as an infringement on its sovereignty. On the other hand, proceeding without a joint body would probably force the EFTA states to accept unilateral decisions of the European Court of Justice, which could be politically difficult. A compromise is possible, however, since the EFTA countries appear willing to accept that the EES will be based on EC law.
While the EC has made progress in creating various types of trans-Community corporate entities and in formulating an EC-wide merger policy, EFTA firms are more concerned about receiving equal treatment within the internal market. Highly discriminatory policies are not expected. But the outlook for third countries is not clear and may not be settled until the EC has clarified its own position on these matters. Equality of treatment may be addressed in EES discussions. A possible sticking point is the EFTA countries’ laws on foreign ownership of domestic firms. At present all EFTA members, except Austria, limit foreign ownership of private non-financial joint stock companies. However, several EFTA countries have liberalized legislation in this area and further liberalization is being contemplated. The EC Commission, for its part, has been insisting that the EFTA countries strictly limit the list of exceptions to EC legislation.
Changes would also appear desirable in the areas of industrial and intellectual property rights—notably counterfeiting, trademarks, copyrights, and patents. Although progress has been made both within the EC and in joint talks on counterfeiting and trademark legislation, the EC is moving slowly in copyright legislation and is deadlocked on patents. Progress is not likely until the EC resolves its own differences in these areas. Joint progress will likely be made on either an inter-bloc basis, probably under the Oslo-Brussels process, or through bilateral talks. However, in some cases, such as the Nordic group on copyright legislation, subgroups of the EFTA could get involved.
While most trade within and between the EC and EFTA is free from conventional barriers, Western European markets remain fragmented. Although tariffs and quantitative restrictions on trade in the region have largely been abolished, other obstacles remain. Some are imposed by governments, such as border controls, technical standards, and public procurement rules. However, private anti-competitive strategies aimed at exploiting market power may also be important. It is unclear whether the internal market program will eliminate all of these more subtle obstacles.
Integration is seen as beneficial for several reasons. It allows specialization based on comparative advantage; it allows greater scale economies; and it encourages competition. However, since trade costs in Western Europe are already low and factor endowments are relatively similar, the gains from comparative advantage may be quite small. The gains from increased scale economies and greater competition are likely to be much larger.
There seems to be little doubt that the internal market will bring gains to the EC. However, these gains are difficult to quantify. First, there is no general theory of imperfect competition, and empirical estimates tend to be highly sensitive to the underlying assumptions. Most of the gains are likely to result from the effects of market integration rather than reduced trade costs. However, while firms may be less able to discriminate between markets, it is difficult to predict the extent to which the internal market program will end such practices. Second, comparisons of second-best solutions are difficult.
If the EFTA countries fully participate in EC integration, they will also share in the gains from the internal market program. While the effects are similar to those on EC countries, the smaller home markets of EFTA countries may imply greater potential gains than in some EC countries. However, the EFTA countries may also have to bear some costs, if they are required to coordinate their external trade policies with those of the EC.
A decision not to integrate further with the EC is likely to result in some losses for the EFTA countries, both relative to the current situation and relative to full integration with the EC. These losses would arise because EFTA firms would become less competitive vis-à-vis their EC counterparts. As trade barriers are eliminated within the EC, demand will tend to shift from EFTA products to EC products, which will depress production in the EFTA. To avoid a deterioration in competitiveness, EFTA firms may be tempted to shift production to the EC. In order to maintain employment within the EFTA, the deterioration in EFTA terms of trade would need to be offset through reduced relative labor costs.
An examination of the economic objectives of the internal market program and the outlook for EC-EFTA relations suggests that—while concessions may be needed from the EFTA—the internal market should have a generally positive impact on the EFTA economies. Prospects for goods trade appear quite favorable. The costs of border controls are falling. While it may not be possible to end inter-bloc border controls—which will put EFTA firms at a slight disadvantage relative to EC firms—the costs of the remaining barriers have declined because of the Single Administrative Document (SAD) for customs clearance. Costs should decline further following the planned computerization of customs data and customs procedures. In addition, EFTA firms will benefit from the free movement of goods within the EC.
The outlook for harmonization and mutual recognition of technical standards and regulations is also favorable. The EC and EFTA are both members of CEN/Cenelec—the two major multinational standards-setting groups in Western Europe—and the EC has agreed to take the EFTA’s views into account when formulating its positions. Progress in joint recognition of certification and testing is also likely. However, several EFTA members have strict industrial standards, notably on the environment, and retaining these standards may be seen as discriminatory by the EC.
The chances for a pact on public procurement are less certain. Progress is most likely to come under the umbrella of the EES. So far, the only agreements have been on strategy and on exchanges and publication of data. The EC has recently made some progress, but serious talks with third parties may have to await further progress within the EC, for example, on government procurement of services. However, the EFTA may also face problems formulating a unified position on this topic. Successful inter-bloc talks may depend on the momentum of the whole EES process. If joint progress is not achieved, the EFTA countries are likely to be subject to the same rules as other third countries. The recent EC directive on public procurement in formerly protected sectors allows EC countries to discriminate against firms from non-EC countries unless the bids meet minimum “European content” requirements.
Much progress has been made regarding rules of origin, but difficulties remain. For some time, the key problem for the EFTA countries was that their FTAs with the EC were bilateral, with no cumulation rules for inputs from other EFTA members. These rules were broadened in January 1989. However, concerns remain about the EC’s anti-dumping laws. There is some fear that preserving market shares in the EC after the startup of the internal market may require price cutting, which could be treated as dumping. The EC has said it will not exempt EFTA members from these rules unless they agree on a uniform set of competition rules. Previously, such an accord did not seem likely, but a solution may be found as part of the talks relating to the EES.
Inter-bloc talks on state aid are under way. The initial goal is to develop a joint reporting system and a system for consulting on problem cases. One difficulty is that the EFTA has no monitoring or enforcement procedures. Work on monitoring has begun, but an enforcement mechanism is not likely to be developed except as part of a broader EES agreement.
Talks on fishing rights and trade in fish are problematic. The EC seems divided on allowing a country’s fish exports free access to EC markets without its granting the EC access to its fisheries. Iceland is the only EFTA country that views fisheries as a major concern. Fishing is the backbone of Iceland’s economy and there is a political consensus that this issue is non-negotiable. However, Iceland needs to retain its access to the EC and hopes to improve it. Therefore, it may be willing to support other aspects of the EES in exchange for concessions in this area.
Most talks on transport issues are still preliminary. While the EFTA committee on transport has begun discussions with the EC, the outlook is not likely to become clear until the EC formulates its own position in this area. The outcome is likely to take one of two paths: an accord will either be made on an inter-bloc basis—possibly as part of the EES—or between individual EFTA countries and the EC on a case-by-case basis.
Both the level of interest and the negotiating positions of EFTA members vary across issues. Austria and Switzerland are highly interested in road transport. They are also located on key intra-EC transport routes, so their bargaining position is strong. On the other hand, the Nordic members of the EFTA have relatively limited interest in road transport issues, since they are physically separated from the continent. Marine transport is important to the Nordic EFTA members but not to the Alpine members. However, little firm progress has been made in either of these areas.
All EFTA members are interested in air rights and have been invited to negotiate on this issue with the EC. Norway and Sweden are likely to receive favored treatment since their main carrier, SAS, is partly owned by interests in Denmark and is being treated as an EC carrier. The EFTA’s argument that air transport rules are best handled on a Western European basis appears well founded, but the success of these talks—beyond a likely accord between the EC and Norway and Sweden—could hinge on the success of the EES. Otherwise, a basis may be found by examining a range of transport issues together.
Prospects for liberalization of the movement of people within Western Europe are not yet clear. The EC views labor mobility as essential for the efficiency of the internal market. The EFTA countries have agreed in principle with this objective for the EES, and some progress has been made in reducing technical barriers to mobility in Western Europe. While there are concerns about labor mobility in several EFTA countries, only Switzerland has publicly raised official objections. It appears likely, however, that political support can be raised within the EFTA countries for such an accord unless it is part of a wider agreement on the EES. Even in this case, Switzerland may seek a partial exemption, and some EFTA countries may retain the right to introduce restrictions under certain circumstances. However, as noted, the EC has been taking a firm line on such exceptions.
Financial integration is central to the internal market program. Free capital flows and trade in financial services are expected to yield substantial gains for the EC. Similar gains would accrue to EFTA members if they integrate further with the EC in this area. The EFTA countries share many of the EC’s objectives in this field, and prospects for greater cooperation appear favorable. The EFTA countries have all deregulated their domestic financial markets and most have liberalized capital movements or are in the process of doing so. They are also revising their legislation and practices for financial institutions to conform more closely with internationally accepted standards and with those of the EC. Restrictions on foreign ownership may pose problems, however, notably among the Nordic countries.
Closer financial integration with the EC would give the EFTA countries’ financial institutions improved access to EC markets, but they would also face increased competition at home. The effects of this may vary among countries. Switzerland seems to have the most developed financial institutions in the EFTA. Norway, and particularly Iceland, may face greater challenges. However, a decision not to integrate is also likely to incur some costs. Larger EFTA customers would tend to turn abroad for financial services, while smaller customers would be deprived of this potential benefit.
With respect to the possible participation of the EFTA countries in the EC’s formal monetary and exchange arrangements, a central question is whether or not the EES forms an optimum currency area. One approach, based on necessary preconditions, seems to support the EFTA countries joining the EMS. However, a second approach, which argues that an optimum currency area requires similar policies and objectives in the member countries, would suggest that only Austria and Switzerland should join. A third, the cost-benefit approach, which examines the effects of joining a different exchange rate regime, does not yield a clear answer. It finds that the decision must be based on key value judgments, for example, whether the loss in policy autonomy is compensated for by gaining credibility through exchange rate commitments. The fact that—apart from Austria—only Norway has expressed an interest in EMS membership shows that there is no homogeneous opinion within the EFTA. However, increasing financial integration in Europe strengthens the need for policy cooperation with the EMS, either formal or informal.
Tax harmonization has emerged as an internal market issue primarily with respect to indirect taxation. With the elimination of border controls, the fiscal checks required for the operation of the present VAT system will disappear, while the scope for cross-border trade increases. The EC Commission has proposed administrative reforms, permitting the VAT system to continue to operate according to the “destination principle.” It has also called for a degree of harmonization of VAT and excise tax rates so as to reduce the potential gains from cross-border trade. In both respects, the implications for the EFTA are limited as long as border controls remain in effect between the EC and the EFTA. To the extent that harmonization in the EC—whether by agreement or by competitive pressure—leads to a lowering of tax rates, the incentives for cross-border shopping by EFTA nationals in the EC will increase (for example, between Denmark and Sweden), but such shopping will remain subject to border checks.
Harmonization of capital income taxation is a longstanding issue in the EC, and one that has become increasingly urgent with the liberalization of capital flows. However, relatively little progress has been made toward concerted initiatives in this area. The issue is important for the EFTA countries as well, since they too are rapidly achieving full capital mobility. At present, it appears that in both blocks harmonization will be propelled by competitive, downward pressure on tax rates rather than by agreement, and the proliferation of tax reforms suggests that this process is already under way. Such a process may impose particular hardships on such high-tax countries as Sweden and Norway, where substitute revenue sources may be difficult to find.