Abstract

The European Communities (EC) were established by the Treaty of Paris (1951) and the Treaties of Rome (1957).1 The original six EC members2 were later joined by the United Kingdom, Ireland, and Denmark in 1973, Greece in 1981, and Spain and Portugal in 1986. Excluding intra-area trade, the EC now accounts for almost one fifth of world exports and nearly as much of world imports. Its weight in world trade is thus somewhat less than that of the United States and Japan taken together (Table 9).

Overview

The European Communities (EC) were established by the Treaty of Paris (1951) and the Treaties of Rome (1957).1 The original six EC members2 were later joined by the United Kingdom, Ireland, and Denmark in 1973, Greece in 1981, and Spain and Portugal in 1986. Excluding intra-area trade, the EC now accounts for almost one fifth of world exports and nearly as much of world imports. Its weight in world trade is thus somewhat less than that of the United States and Japan taken together (Table 9).

Table 9.

European Community: Share in World Trade

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Source: International Monetary Fund, Direction of Trade Statistics.

Includes the original six EC members plus Denmark, Greece, Ireland, and the United Kingdom. The same group of countries is maintained throughout the period to avoid distortions arising from EC enlargement.

Includes the present six EFTA members throughout the period.

The institutional structure of the Community, organized along the lines of a national administration, consists of the EC Commission, the Council of Ministers, the European Parliament, and the European Court of Justice, which constitute the administrative, legislative, and judicial branches of the EC. The Commission implements Community policy, enforces EC treaties, and proposes legislation to the Council. The Council, which is primarily a forum for national interests, is the final decision-making body. The Presidency of the Council of Ministers rotates among EC member countries on a semiannual basis. The European Parliament, elected by popular vote, has advisory powers under which it delivers to the Council nonbinding opinions on Commission proposals and has supervisory powers over the Commission. The Parliament is also responsible for final approval of the EC budget, although it has limited power to amend it. The budget finances the EC’s Common Agricultural Policy as well as EC regional and social programs using revenues from the common external tariff and contributions paid by Community members. More recently the Parliament acquired the power to reject or amend Council decisions pertaining to the unification of the EC market under the Single European Act. The Court of Justice interprets and applies EC treaties and enforces Community law, EC Heads of State or Government are referred to as the European Council and their meetings are often referred to as “EC Summit Conferences.” Though not an official decision-making body under the EC Treaties, the European Council can reach politically important understandings or agreements, for instance, on the EC budget. Each member state of the EC, and the European Economic Community (EEC) as a separate entity, are members of the GATT. Within GATT they are represented by the Commission.

The EEC Treaty that took effect on January 1, 1958 provided for the elimination of trade barriers within the Community and the establishment of a common external tariff against the rest of the world. Besides establishing a customs union, the treaty provided for a common market permitting the free movement of capital and labor within the Community. Customs duties and quantitative restrictions on intra-area trade were progressively reduced and were eliminated in July 1968, one and a half years ahead of schedule. This contributed to an increase in intra-area trade, from 38 percent of total EC trade in 1960 to 58 percent in 1987, most of which occurred between 1960 and 1970 (Table 10). Progress in liberalizing factor movements within the Community, however, has been somewhat slower.

Table 10.

European Community: Level and Direction of Trade

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Source: International Monetary Fund, Direction of Trade Statistics.

Includes the original six EC members plus Denmark, Greece, Ireland, and the United Kingdom. The same group of countries is maintained throughout the period to avoid distortions arising from EC enlargement.

Includes the present six EFTA members throughout the period.

In addition to establishing a common market, the EEC Treaty provided for a common agricultural policy (CAP),3 This was viewed as an essential step toward freeing intra-area trade in agriculture, given the diversity of existing support schemes in the six original EC member countries and the perceived need to protect the agricultural sector. The CAP aimed to maintain a fair standard of living for farmers, reasonable prices for consumers, and to stabilize markets. These objectives have increasingly proved conflicting. Agricultural support has been provided at a high cost to consumers, taxpayers, and nonagricultural producers in the EC, and together with policies of other major industrial countries, has had adverse effects on efficient agricultural exporters.

With the exception of the common external tariff and the CAP, the Community’s commercial policy relative to third countries was not clearly defined in the EEC Treaty. Article 113 governing EC commercial policy merely enumerated examples of commercial policy measures without spelling out the regime governing the exchange of goods and services and the movement of labor and capital between the EC and third countries. Common rules for all EC countries have not so far been established because of divergent views among member states on the desirable level of restrictiveness of the Community’s external regime. Thus, EC countries generally maintain national quantitative restrictions on imports from third countries enforced through national import licensing systems, standards, and certification procedures. The Community nevertheless possesses a number of common commercial policy instruments in addition to the common external tariff. These include EC-wide quantitative restrictions and legislation dealing with unfair trade practices abroad.

Industrial policies in the EC are regulated through the EC Treaties’ provisions on competition,4 which include those of the EEC Treaty on state aids and those of the ECSC Treaty provisions on the coal and steel sectors. The purpose of these provisions is to limit state aids and business practices that restrict competition within the Community. To the extent that state aids are permitted, they may substitute for tariff protection within the Community; they may also substitute for border measures in providing protection against non-EC members. The Commission has recently tightened its surveillance over state aids and has in some cases demanded that aids incompatible with the treaties be reimbursed.

The EC has concluded preferential arrangements with other countries and groups of countries, including free trade agreements with each country of the European Free Trade Association (EFTA),5 and cooperation and association agreements with a number of Mediterranean countries. Discussions are under way to increase cooperation with the Gulf Cooperation Council (GCC). In addition, the EC provides nonreciprocal tariff preferences to a number of African, Caribbean, and Pacific (ACP) countries under the Lomé Convention and to all developing countries under the Community’s Generalized System of Preferences (GSP) scheme. Preferences granted under bilateral agreements have given rise to complaints by developing countries that do not benefit from them.

Beyond the EEC Treaty provisions on free mobility of goods, services, and factors of production within the Community, the European Council agreed in The Hague in December 1969 progressively to establish a monetary union. This has so far proved unfeasible for economic and political reasons. Monetary integration requires coordination of monetary policies as well as a high degree of mobility of goods and factors of production.6 However, the establishment of the European Monetary System (EMS) in March 1979 was a significant institutional development in this direction. The objective was to create a “zone of monetary stability in Europe” through a system of fixed but adjustable exchange rates among EC members. Although all EC countries have signed the EMS agreement, only eight actively participate in its exchange rate mechanism.7 While there have been several currency realignments since its inception in 1979, the EMS is generally considered successful in promoting convergence of economic policies and developments in member countries.8 More recently, proposals for progress toward the establishment of a European central bank and the adoption of a common EC currency have been advanced by France and were included on the agenda of the European Council summit in Hannover in June 1988. A high-level committee established by the European Council is to make recommendations in June 1989 on further concrete measures to accelerate monetary integration. Impetus to the discussions on monetary unification has been provided by the ongoing efforts to integrate further the Community’s market.

The trade and industrial policies of the Community have evolved through compromise among its members, A consensus within the Community has not always emerged. Although the Community institutions were given the mandate to implement the EEC Treaty, national interests have often taken precedence over Community goals. Despite the elimination of internal tariffs and quantitative restrictions, a number of barriers to intra-area trade continue to exist, including government procurement policies, technical standards, and border formalities. In the area of services, which was also covered by the EEC Treaty, national regulations discriminate in favor of domestic suppliers. National regulations also limit labor mobility, and most EC countries maintain restrictions on capital movements.

The costs arising from the fragmentation of the EC market have been increasingly recognized by EC members as the initial trade-creating effects of the EC gave way to a virtual stagnation of intra-EC trade as a proportion of total trade. To integrate the internal market further, in June 1985 the EC Council adopted a White Paper that outlined a far-reaching program aimed at removing all remaining barriers to the free movement of goods, services, and factors of production by 1992. Progress in implementing the White Paper is reviewed below. Access by third countries to the benefits of the integrated internal market will depend to some extent on reciprocal market-opening measures by the EC’s trading partners, and the EC is therefore pursuing multilateral and bilateral negotiations to liberalize trade on a reciprocal basis. The Uruguay Round provides a forum for an exchange of trade concessions, given that its agenda overlaps with the EC internal market program. While this approach has been criticized by some of the EC’s trading partners as possibly fragmenting the world trading system, it might also contribute to faster progress in multilateral liberalization of trade.

Trade Policies

Common External Tariff

The Community’s common external tariff was introduced in 1968 and lowered during the subsequent Tokyo Round of Multilateral Trade Negotiations. Post-Tokyo Round most-favored-nation tariff rates for major products for the EC, the United States, and Japan are set out in Table 11. At 7.8 percent, the unweighted average EC tariff rate is above the U.S. average but below Japan’s average, which is raised by Japan’s high average tariff on food products. Tariff peaks are less important in the EC than in the United States or Japan, as indicated by the coefficient of variation of EC tariff rates. Tariff escalation, however, is quite marked in the EC (as in other industrial countries), as indicated by the lower tariffs on raw materials, fuels, and metals compared with manufactured products.

Table 11.

European Community, United States, and Japan: Average Tariff Rates1

(In precent)

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Source: United Nations Conference on Trade and Development.

Unweighted post-Tokyo Round most-favored-nation tariffs.

Ratio of standard deviation of tariff rates to unweighted average rate.

The EC’s applied tariff rates on imports of industrial products are lower than the GATT bound rates. By contrast, applied tariffs are equal to bound rates on agricultural products. Exceptions to the common external tariffs of the EC are made for imports entering under its GSP scheme and under the preferential trade agreements that it has negotiated with other countries or country groups.

Common Agricultural Policy

The Community’s Common Agricultural Policy (CAP) consists of a set of measures designed to support farm incomes and improve productivity in the farm sector. The measures consist of price regulations enforced through government purchases and stockpiling of excess production, import levies and quotas, and export subsidies, referred to as restitutions. Starting in 1988, the CAP instruments also include a land set-aside scheme and ceilings on agricultural expenditure financed from the EC budget.

The support mechanism covers about 90 percent of EC agricultural production and varies somewhat among agricultural products. For most agricultural products, support takes the form of “target” prices that are the upper end of the range within which prices are permitted to fluctuate. At the lower end of this range is the “intervention” price at which specialized public entities are obliged to buy any quantities offered to them. Intervention prices exceed world prices by considerable margins in most cases. Protection against imports is provided through variable levies set at a level that equalizes import prices to a reference price (often referred to as “threshold” price) set at around the middle of the range between target and intervention prices. For exports, variable subsidies, referred to as restitutions, are provided to exporters to offset the difference between EC and world market prices. The variability of import levies and export subsidies insulates the EC farm sector from exchange rate movements between EC currencies and those of competing suppliers. Exchange rate movements among EC currencies are similarly offset through monetary compensatory amounts (MCAs), to ensure the equality of agricultural prices expressed in ECUs within the Community. Specifically, MCAs serve as import taxes and export subsidies for countries that revalue their currencies, and vice versa for countries that devalue. These amounts are being progressively phased out.

A number of recent studies have concluded that agricultural support in a number of countries, including the operations of the CAP, have depressed world prices by encouraging surplus production (see Section V). This effect is exacerbated by subsidized exports of surplus production to third countries. Agricultural protection in the Community has given rise to a number of trade disputes with the United States, which relies more heavily on acreage limitation incentives as a means of support. The EC has been the main target of the U.S. Export Enhancement Program (EEP), which provides subsidies to U.S. exporters to enable them to compete with heavily subsidized foreign exporters. This, in turn, has further depressed world prices of agricultural products.

The CAP also imposes heavy costs on taxpayers and consumers within the EC and has adverse effects on the overall macroeconomic performance of member countries (see Section V). Until recently, the budgetary cost of the CAP was borne entirely by the EC budget. Additional spending on agricultural support (at member countries’ own initiative) occurs through the national budgets. National support is three times higher than spending through the EC budget in some EC countries. The rising budgetary cost of the CAP, which amounts to some $35 billion annually and accounts for two thirds of EC budget expenditures, has led in recent years to reform efforts. Past efforts mainly took the form of limits on entitlement to support, production quotas, and price restraints; measures agreed in February 1988 also included a land set-aside scheme and limits on spending from the EC budget on price support. However, barriers to access remain largely intact.

Quantitative Restrictions

The EC and its individual members maintain quantitative restrictions on imports of a number of industrial and agricultural products from selected third countries. These restrictions include quotas on textiles and clothing under the Multifiber Arrangement (MFA), national “residual” restrictions that predate the EC (see below), and voluntary export restraints (VERs).9 Preliminary data indicate that the EC accounted for 138 of 261 known VERs, excluding quotas concluded under the MFA, as of end-May 1988 (Tables 12 and 13). Between September 1987 and May 1988 the number of VERs doubled in the EC, compared with a 74 percent increase in the rest of the world.10 These restrictions are increasingly directed against exports of developing countries: they rose to nearly one half of the total in May 1988 from one third in September 1987. Trade with state-trading countries is governed by separate, more restrictive EC regulations that permit the maintenance of national quotas.

Table 12.

European Community: Voluntary Export Restraint Arrangements, September 1987

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Source: General Agreement on Tariffs and Trade, Review of Developments in the Trading System (Geneva), 1987.

Industry-to-industry arrangement.

Table 13.

European Community: Voluntary Export Restraint Arrangements, May 1988

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Source: General Agreement on Tariffs and Trade, Review of Developments in the Trading System (Geneva), 1988.

Industry-to-industry arrangement.

The quantitative import restrictions maintained by the EC fall under two broad categories: EC-wide restrictions and national restrictions. The latter include some restrictions imposed by member governments that are recognized by the Community, and industry-to-industry export restraint arrangements that do not involve member governments and are not recognized by the Community.

EC-wide restrictions include those concluded under the MFA as well as a number of VERs. Import quotas negotiated under the MFA by the EC Commission are split into subquotas applying to individual member countries. As of May 1988, the EC had concluded 20 bilateral agreements on textiles and clothing under MFA IV. VERs are maintained on imports of steel, textiles, clothing, agricultural and food products, machine tools, automobiles, and electronic products. With one exception (footwear), these are government-to-government arrangements. Imports of steel are governed by bilateral quotas or minimum prices that, if not observed, can lead to dumping actions against foreign suppliers; these restrictions apply to a wide range of exporting countries including Japan and other industrial countries, newly industrializing economies and state-trading countries. Outside the MFA, the EC has 18 additional bilateral agreements on textiles and clothing, including bilateral agreements with Turkey under the safeguard provisions of Turkey’s association agreement with the EC, and agreements with Bulgaria, Egypt, the Islamic Republic of Iran, Morocco, Tunisia, Yugoslavia, and a number of Latin American countries.

National restrictions include VERs and other gray-area measures as well as residual restrictions. Voluntary export restraints apply mainly on imports of automobiles and transport equipment, electronics, and footwear and are either government-to-government or industry-to-industry agreements. Most of these restrictions protect the markets of France, Italy, and the United Kingdom. Imports of automobiles from Japan are restricted in France, Italy, Portugal, Spain, and the United Kingdom.11

The so-called residual restrictions remained in place after most quantitative restrictions were lifted in the first 15 postwar years. In 1955, the GATT adopted a decision known as the “hard core waiver,” which permitted the maintenance of certain restrictions for a specified time period. The residual restrictions remaining in force (after the waivers issued under the GATT’s 1955 decision lapsed) are incompatible with the provisions of GATT Article XI, which calls for the general elimination of quantitative restrictions. 12 The EC has offered to abolish some of these residual restrictions, which constitute only a small proportion of national restrictions maintained by EC members, as part of its rollback commitment in the Uruguay Round.

Enforcement of Quantitative Restrictions

EC-wide restrictions are enforced through import licensing procedures applied at the Community level (see below). National restrictions on imports of goods from third countries that are in free circulation within the Community are enforced through Article 115 of the EEC Treaty or, if restrictions are not officially recognized by the EC, through national import licensing or standards and certification procedures.

Article 115 empowers the Commission to authorize a member country to apply protective measures against imports from third countries if such imports threaten the domestic production of the item concerned. An Article 115 authorization temporarily restricts free circulation of goods within the Community and prevents circumvention of national restrictions through imports from other member countries. Most of the existing Article 115 authorizations relate to imports of textiles and clothing under the MFA (Table 14), but have also been granted for imports of automobiles, footwear, and other industrial products as well as agricultural products. Since industry-to-industry restrictions on automobiles (e.g., those in France and the United Kingdom) are not approved by the Commission, they are not covered by Article 115. In principle, it would be possible to bypass the French restriction by importing Japanese automobiles from other EC members, but in practice, this is prevented by national automobile standards and certification procedures, which are scheduled to be eliminated by 1992.

Table 14.

European Community: Authorization of Article 115 Actions,1 1980-87

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Source: Data provided by the Commission of the European Communities.

Temporary restrictions on free circulation of goods within the Community under Article 115 of the Treaty of Rome.

The criteria for granting Article 115 authorizations were tightened in 1974 and 1979, and the trend since 1979 has been toward further tightening. Although the percentage granted of the total requested has increased, the number requested has been halved over the period 1980-87. In assessing members’ requests, the Commission takes into consideration the evolution of total EC imports of the item concerned relative to the individual member’s imports, past patterns of intra-EC trade, as well as the profit position and employment situation of the industry. In principle, recourse to Article 115 would no longer be possible once internal borders disappear upon completion of the internal market in 1992. This would have implications for the nature of bilateral agreements under the MFA if it were to be renewed after its expiration in 1991; the Commission is reviewing these implications to ascertain the feasibility of replacing national restrictions with EC-wide restrictions.

Import Licensing

Import licensing procedures13 are applied at the Community level as well by some individual members for import control purposes.14 At the Community level licenses are required for imports of industrial or agricultural products that are subject to quantitative restrictions or monitoring. Separate regulations apply for imports of products originating in state-trading countries and for imports of textiles from third countries. Automatic licensing is granted to imports that are subject to surveillance. Surveillance is often, but not always, the precursor to restrictions (as it was with EC-wide restrictions on Japanese automobiles). Imports subject to quotas require prior authorization, which is provided under nonautomatic licensing procedures. For products subject to export restraint arrangements, an import authorization is granted on the basis of the export permit issued by the exporting country. The Commission is authorized to require licenses for imports that cause or threaten to cause injury to Community producers or when “critical circumstances” make immediate action necessary. Licensing requirements, necessary to implement safeguard measures taken under Article XIX of GATT, are subject to EC Council confirmation.

Community-wide quotas are allocated among member countries on the basis of agreed shares. Member countries grant import authorizations within the limit of their quota shares. To ensure that the licenses issued are actually used, each member country must notify the Commission on a monthly basis of the amount of import authorizations and actual imports in the preceding month. Based on this information, the allocation of the quota among member countries may be modified.

Other Trade Instruments

The EC is a signatory to all codes and agreements adopted during previous multilateral trade negotiations. These include codes dealing with import licensing (discussed above); government procurement; technical barriers to trade; trade in civil aircraft (see Section VI); subsidies and countervailing duties; antidumping duties; customs valuation; and dairy and beef products.

As in other major industrial countries, government procurement policies and technical barriers protect the EC market from outside competition. It is difficult to gauge the importance of these barriers compared with tariffs, nontariff border measures, and subsidies. It is expected, however, that the reduction or removal of such barriers among EC members as part of the process to integrate the internal market would result in significant benefits for the Community.

Policies of the EC that deal with subsidies, dumping, and other unfair trade practices play an important role in EC trade relations with other countries. They include definitions of subsidies and dumping and outline the procedures governing the Commission’s investigations. The definition of dumping under EC procedures is based on the price prevailing in the exporters’ domestic market. If this price is not considered representative of costs because of market imperfections, the antidumping investigation is based on estimated production costs, which assume average cost pricing and may be subject to a considerable margin of error. In line with GATT provisions, the imposition of antidumping or countervailing duties requires a positive finding of injury.

In 1984, new regulations governing subsidies and dumping, which broadened and sharpened the scope of existing rules, came into effect. In 1986, the EC extended the concept of “unfair” trade practices to a service industry (shipping), which is not covered by GATT rules. The legislation allows the Commission to take offsetting measures against countries or shipping lines practicing “predatory” pricing. In June 1987, the concept of antidumping was extended to so-called screwdriver plants established by non-EC producers in the EC. The legislation aims at preventing circumvention of antidumping duties on finished products and allows duties to be imposed on products assembled in the Community if certain conditions are met. First, the screwdriver operation must be closely related to the firm on which dumping duties have been imposed and must have been established, or have substantially increased its operations, following the imposition of antidumping duties on the finished product. Second, components imported from the country against which the initial antidumping duty was levied have to amount to at least 60 percent of the price of the finished product. (To avoid an antidumping duty, therefore, at least 40 percent of the finished product must be produced locally or in a third country.) The EC justified the new legislation on the grounds that any action undertaken to enforce antidumping duties on the finished products, imposed on the basis of GATT Article XX, was legitimate. The alternative of initiating antidumping investigations on each of the imported components was considered impractical because of the large number of components involved. Japan, which is affected by the legislation, has questioned its conformity with GATT rules.

In 1984, the EC adopted the New Commercial Policy Instrument, intended to counter “unfair” trade practices abroad. This is analogous to Section 301 of the U .S. Trade Act of 1974. Unfair practices are defined as any measures incompatible with generally accepted practices or with international codes or rules agreed multi-laterally in GATT, the OECD, or other international institutions and agreements. The New Commercial Policy Instrument applies to situations where an EC member believes that its access to the markets of another country may have been unfairly reduced as a result of trade practices that the importing country considers not inconsistent with GATT rules. Complaints may be presented to the Commission by member countries or by an association representing an industry throughout the Community. In the event of a positive determination, the Commission must decide on actions to be taken to defend the Community’s interests. No actions were taken on the three cases that have been investigated under this legislation.

The EC has initiated very few countervailing investigations, in part because its antidumping provisions are easier to invoke and also because imports of some products that are subsidized directly in other countries, such as steel and agricultural products, are subject to EC or national quantitative restrictions or to pricing disciplines.15 Frequent use is made of its antidumping legislation. Antidumping investigations tended to decline in the first half of the 1980s when the U.S. dollar appreciated, but have recently increased. The number of antidumping investigations declined from 39 in 1984 to 36 in 1985 and to 24 in 1986, but rose to 34 in 1987. 16 Of a total of 68 antidumping investigations under way in 1986, 4 ended with the imposition of definitive duties, 25 were concluded with price undertakings by the exporters, and the remaining ended without penalties being imposed. In 1987, 4 countervailing duties and 15 antidumping duties were imposed on a number of products, including steel, chemicals, and electronics; most duties affected exports of developing and state-trading countries.17

An investigation was launched under new shipping legislation in November 1987 against a Korean shipping line on the rates charged on cargo lines between the Community and Australia. The Commission is investigating the complaint, initiated by the EC Association of Shipowners, and has invited information and comments from interested parties. EC exporters have opposed measures against Korea on the grounds that the low rates charged by the Korean shipping line permit them to be competitive on the Australian market.

Of a total of four investigations opened under the new legislation on screwdriver operations, three have been completed. Two of these have resulted in antidumping duties and one was dismissed because the 60 percent import content requirement was not reached. All the investigations were directed against Japanese manufacturers and involved electronic typewriters, weighing scales, photocopiers, and construction equipment.

Trade-Related Aspects of Industrial Policies

Industrial policies in the EC are regulated through the EEC Treaty’s provisions on competition and through the ECSC Treaty that established the European Coal and Steel Community. These provisions regulate the provision of state aids and thus have a bearing on the extent to which such aid may distort trade. Competition provisions, which also cover restrictive business practices, aim at striking a balance between market forces and selective intervention by public authorities. The objective is to ensure that (a) resources are channeled to industries that contribute to growth and competitiveness; (b) state intervention does not permit a company or sector to gain an unfair advantage over its competitors in other member countries; (c) dominant positions arising from monopoly power are not abused; and (d) state aid policy is consistent with other policies, such as regional and research and development policies. In some cases state aids are permitted in such a form as to insulate essentially certain sectors from developments in world markets, including exchange rate changes.

Regulation of State Aids

The EEC Treaty’s provisions on state aids are contained in Articles 77 and 90-94. In principle, state aids are prohibited by Article 92(1) insofar as they distort competition and affect intra-Community trade. The Treaty includes statutory exceptions and, in addition, the Commission has discretionary power under Article 92(3) to grant exemptions for state aid that meets specific criteria. Exemptions are granted with respect to the following:

(a) Regional development aid to benefit the relatively poorer regions of the Community: Greece, Portugal, Ireland, Northern Ireland, Italy’s Mezzogiorno, and several regions of Spain. The Community contributes to the financing of regional aid through the European Regional Development Fund (ERDF) and the European Social Fund (ESF), The objective of these funds is to help correct the most serious regional imbalances in the Community and contribute to the restructuring of declining industrial areas.

(b) Aid to develop economic activities or areas where the degree of distortion in trade and production within the EC would not be substantial. These aids relate mainly to regional programs in higher-income countries (e.g., the Federal Republic of Germany) and could include research and development expenditure.

(c) Schemes in the common European interest: projects with high start-up costs, including research and development costs, which may be financed jointly by some member countries (e.g., Airbus).18

Article 93(3) requires EC member governments to give prior notification to the Commission of all financial assistance. The Commission determines whether individual state aids fall within its jurisdiction under Article 93 and reviews their consistency with EC regulations.19 Based on its review, the Commission may approve the state aids proposed, recommend modifications, or forbid them. The Commission’s decision may be appealed to the European Court of Justice by any of the interested parties. Alternatively, the Council of Ministers can, by unanimous vote, overturn the Commission’s decision; the latter occurs in exceptional cases and in the past has mostly involved agricultural products. The Commission also has authority under Article 93(1) to review existing state aids for their continued consistency with EC rules, including schemes maintained by new members. In principle, competition laws apply to new members immediately on accession. In the case of Spain, however, special treatment was accorded to the steel sector, for which state aids that were inconsistent with EC rules were permitted during a transition period.

State Aids to Steel, Coal, and Shipbuilding

State aids to steel and coal are governed by Articles 4, 54, and 95 of the ECSC Treaty. The Treaty also allows the Commission to impose controls on production and prices and is stricter than the EEC Treaty in that it provides for the suspension of all subsidies at the end of a transition period.20 Article 95 does provide, however, for “appropriate amendments” in case of unforeseen difficulties after the end of the transition period. The code on state aids to steel, adopted in 1980, called for the termination of operating subsidies by the end of 1984 and of most other aids by the end of 1985. Although state aids to steel are permitted only in connection with restructuring leading to capacity reductions, operating subsidies apparently continue to be provided to the steel sector in some member countries.

The Commission is less active in regulating state aids to the coal sector, partly because not all member states have coal mining industries and the likelihood of distortions in trade and production within the EC is consequently lower.21 Prices in EC countries are maintained above world prices. Many enterprises operating at a loss are kept in operation with subsidies that would be incompatible with the rules for steel or shipbuilding. Under the ECSC Treaty, aid to the coal sector is subject to the Commission’s approval, which is granted if the proposed aid does not distort the internal market for coal. In addition, the proposed aid must meet certain criteria set out in a Commission decision of July 1986. The aid must (i) strengthen the competitiveness of the coal industry, including improving security of national supply; (ii) create new capacity only if commercially viable; or (iii) address regional and social problems arising from pit closures.

The Commission interprets the lack of internal cross-border trade in coal as evidence that operating subsidies are not being used to lower prices artificially to an extent that distorts intra-EC trade, and therefore allows operating subsidies under criteria (i) and (iii). But it does not allow aid to be granted to such an extent that it amounts to indirect support to industrial users of coal, such as the steel industry. Aid to new capacity is allowed up to 50 percent of investment costs, but subject to case-by-case review by the Commission which must satisfy itself that the new installation will be economically viable.

Under these guidelines the Commission allows the Federal Republic of Germany to cover the difference between world prices and those paid by the German iron and steel industry for domestic coal and coke.22 It also has approved an arrangement whereby the extra costs of burning German coal in power plants is passed on to consumers by raising electricity prices. This aid is justified by the German authorities as preventing premature pit closures that contribute to social and regional problems related to developments in the coal industry. This argument, which would not be acceptable to the Commission for steel or shipbuilding subsidies, is also used to justify operating aid provided by Belgium, France, and the United Kingdom.

Aids to shipbuilding are governed by a decision under Article 92(3)d of the EEC Treaty whereby the Commission may recommend to the Council that a particular sector be exempted from normal rules.23 The Community’s directive on aid to shipbuilding, adopted in early 1987, limits operating subsidies to 28 percent of the contract value. This limitation is intended to promote production in the most viable shipyards, by preventing a heavy concentration of state aids to the least competitive yards. The 28 percent limit is subject to annual review and is expected to fall over time as shipyards become more competitive. However, the limit does not apply to exports to developing countries financed by soft loans and grants, nor does it cover export credit subsidies, which are governed by the OECD Consensus Arrangement.24 State aids may also be provided in support of restructuring plans that reduce capacity and in connection with payments to redundant workers, commensurate with the restructuring effort.

Difficulties in Enforcing EC Rules on State Aids

EC rules on state aids have not been enforced strictly because (i) member states do not fully comply with notification requirements to the Commission; (ii) state aids to specific sectors are sometimes provided under the guise of regional or social policy; and (iii) state ownership of enterprises in a number of member countries complicates the implementation of competition policy. EC rules on state ownership require governments to behave as commercial investors would in injecting additional equity into state-owned enterprises. Since it is not always clear how commercial investors might act, the Commission has encountered difficulties in assessing compliance.25 Similar difficulties have arisen in connection with aids aimed at particular sectors but provided by member governments under the guise of regional or social aids. Such aid may in some cases be more than necessary to overcome locational or other disadvantages and may therefore provide an artificial competitive advantage.

Surveillance over State Aids

Surveillance over state aids by the Commission has been tightened since 1985, when the White Paper containing proposals for completing the EC internal market was approved by the Council. This approval reflected the recognition by both Community and national administrations of the need to enforce competition policy effectively to ensure that the removal of internal nontariff barriers is not replaced by other devices that limit competition. Acceptance of this principle by member governments was facilitated by budgetary considerations, pressures from some members for greater control over other members’ activities, the fact that industry-specific subsidies are more likely to be countervailable, and a growing recognition that state aids are neither an efficient nor effective method of encouraging structural adjustment.

Developments in surveillance over state aids have occurred in three main areas since 1985. First, the effectiveness of surveillance was enhanced by a tightening of the procedures applied in cases of non-notified aids. Article 93(2) procedures, providing for the termination of state aids incompatible with EC rules, are now automatically opened if member states do not respond to a request for notification within a limited time. Moreover, the Commission now systematically demands that non-notified state aids that are illegal on either substantive or procedural grounds be reimbursed.26 Demands for reimbursement increased from ECU 11 million in 1986 to ECU 747 million in 1987, and major investigations were initiated in 1988 involving France (automobiles and steel), the United Kingdom (automobiles), and Italy (steel). In some of these cases, however, governments have proved to have more power than the Commission.

Second, the transparency of EC procedures has increased through the publication in the Official Journal of the European Communities of all decisions on state aids issued by the Commission, whether positive or negative, to encourage the intervention of interested third parties.

Third, information on the level and type of state aids is to be improved. An internal task force has been formed to survey state aids in the Community. A preliminary draft was recently discussed by member governments to be published later in a White Paper on EC state aids. The published information may be aggregated across sectors or member countries and expressed as percentages of GDP to avoid possible application of countervailing duties by other countries.

Preferential Agreements with Other Countries

Aside from its GSP scheme, the EC has concluded a number of preferential trade agreements with other countries and country groups. These agreements provide for preferential access to the EC market in exchange for tariff and nontariff concessions on products of interest to the EC. They include a free trade agreement with the EFTA countries, association or cooperation agreements with a number of Mediterranean countries, and preferential access to the EC market on a nonreciprocal basis to 66 African, Caribbean, and Pacific countries.

Three factors provided the impetus for these bilateral trade agreements. First, with the departure of Denmark and the United Kingdom from EFTA to join the EC, the current EC members extended duty-free treatment to the remaining EFTA countries. Second, the Mediterranean countries that conduct a large part of their trade with the EC had a clear incentive to get inside the Community’s common external tariff, especially because a number of their competitors in the Mediterranean area (Greece, Portugal, and Spain) have recently joined the Community. Third, the preferences granted by Belgium, France, and the United Kingdom to their former colonies in Africa, the Caribbean, and the Pacific were extended to the entire Community.

Some contracting parties have questioned the consistency of these agreements with GATT Article XXIV, which stipulates that the formation of customs unions and free trade areas is subject to certain requirements. These requirements include their formation “within a reasonable period of time” and their coverage of “substantially all trade” among the partner countries. For their part, the EC and the other signatories of the agreements have argued that these agreements were fully consistent with Article XXIV and that in addition, when concluded with developing countries, they were covered by Part IV of the General Agreement and by the Tokyo Round decision of November 28, 1979 on differential and more favorable treatment, reciprocity, and further participation of developing countries (the Enabling Clause). The competent GATT working parties have taken note of these opposing views and have not ruled on the issue of the consistency of the agreements with the relevant provisions of the General Agreement and the Tokyo Round agreements.

EFTA Agreements

The free trade agreements between the EC and each of the EFTA countries were signed in 1972 and cover trade in industrial and processed agricultural products.27 Trade in unprocessed agricultural products remains highly restricted. Since the conclusion of the free trade agreements, trade between the two country groupings has quadrupled and currently amounts to about $100 billion, equivalent to 70 percent of EFTA trade and one fourth of EC trade with third countries, excluding trade within the two groups (see Table 10).

By 1984, it was recognized that the scope for furthering trade in the context of the existing agreement was limited. Although cooperation was increasing in the areas of consumer policy, technology, and the environment, EFTA countries were apprehensive that the EC initiatives toward internal integration would reduce access for EFTA countries to the EC market. These factors led to a ministerial meeting between EFTA and the EC in November 1984 and the announcement of a program, contained in the Luxembourg Declaration. The declaration included commitments to reduce technical barriers to trade, eliminate quantitative export restrictions, revise rules of origin, and open up government procurement. Subsequent ministerial meetings expanded the scope of EC/EFTA cooperation to increase the transparency of state aids and simplify border formalities. Services, intellectual property, and capital movements were also included on the agenda.

In line with the above agreements, concrete steps have been taken in a number of areas. Border formalities have been simplified, and agreement in principle was reached to eliminate quantitative export restrictions in the EC that had been introduced for historical reasons.28 On technical barriers, discussions are under way to develop alternative mechanisms for notification and harmonization of technical norms. Negotiations aimed at relaxing the rules of origin under which EFTA was granted duty-free access to the EC are under way with a view to extending the minimum value-added requirement to apply to EFTA countries as a group rather than individually.29 On state aids, EFTA countries have agreed to introduce notification requirements to the EFTA Secretariat, similar to those that exist in the EC vis-à-vis the Commission, Further progress in harmonizing rules may be hampered by the fact that the EFTA Secretariat, in contrast to the EC Commission, is not empowered to enforce competition policy.

Association and Cooperation Agreements

The EC has concluded association and cooperation agreements with a number of Mediterranean countries. Association agreements have been concluded with Cyprus (1972), Malta (1970), and Turkey (1963), providing for reciprocal tariff preferences, aid, industrial cooperation, technical assistance, and full accession to the EC after a transition period. Under the agreements, concluded on the basis of Article 238 of the EEC Treaty, the Community grants duty-free access for industrial exports and tariff preferences for agricultural exports. The associate member countries have not, however, adhered to the timetable for granting reciprocal preferences to EC exports, nor have they adopted the EC common external tariff. A protocol that will complete the customs union with Cyprus was signed in 1987 and came into force on January 1,1988. Under the agreement, Cyprus will remove customs duties on imports of industrial products from the EC and adopt the common external tariff over a ten-year period. The agreement also provides for reciprocal concessions on agricultural exports and the eventual liberalization of agricultural trade beyond the ten-year period.

Cooperation agreements have been signed with Israel (1975), and with Algeria, Egypt, Jordan, Lebanon, Morocco, Syria, Tunisia, and Yugoslavia (1978). The agreement with Israel, concluded on the basis of Article 113 of the EEC Treaty, provides for a free trade area covering most trade in line with the provisions of GATT Article XXIV, While the EC had removed all tariffs and quantitative restrictions on Israel’s industrial exports by 1977, Israel’s deadline for granting the EC reciprocal treatment has been extended twice, to January 1989. Under the agreement, the EC also provides tariff preferences for Israel’s agricultural exports. The EC has granted similar benefits to the other countries with which it has signed cooperation agreements, in exchange for MFN treatment of EC exports to their markets. Trade between the EC and these countries as a group is a negligible portion of EC trade but a significant portion of these countries’ trade.

GCC Cooperation Agreement

The Cooperation Council for the Arab States of the Gulf (Gulf Cooperation Council—GCC), which comprises Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates, has recently requested the negotiation of a trade and cooperation agreement with the EC providing for a free trade area covering all industrial products, including petrochemicals. In November 1987 the EC Council authorized the Commission to negotiate a two-stage agreement with the GCC. The first stage, concluded on June 15, 19S8, includes agreements to increase cooperation in the areas of industry, energy, science, technology, and the environment;30 a “standstill” clause preventing the introduction of new restrictions; and the mutual application of MFN treatment.31 The second stage would include trade liberalization measures that fall short of a free trade area, reflecting both a desire by the EC to maintain sufficient petrochemical production capacity to provide security of supply and the concern of some EC member countries that complete elimination of EC tariffs on their petrochemical industries could harm restructuring efforts in the EC oil refining and petrochemical industries. In exchange, the EC would provide for an infant industry protection clause to benefit the GCC countries. To avoid a reduction in EC protection of its petrochemical industry not matched by similar reductions by the United States and Japan, both parties to the agreement have pledged to promote a multilateral reduction in customs duties on petrochemical products in the Uruguay Round.

Imports of petrochemicals from the GCC countries into the EC are presently governed by the Community’s GSP scheme. The operation of the GSP scheme has been the focus of a dispute between the Community and the Gulf Cooperation Council and has hindered the negotiation of a cooperation agreement. Duty-free access of “sensitive” products, including petrochemicals, under the GSP scheme is subject to annual quantitative limits. Beyond these limits, duties of 13 percent on petrochemicals are applied automatically for some products, or at the request of the domestic industry for others. These limits are usually reached within the first few days of the year, giving rise to complaints by the GCC countries that the Community’s GSP scheme is unhelpful to them. The EC Commission, in turn, views the substantial imports of petrochemicals from the GCC countries as evidence that the tariff does not appear to affect GCC exports adversely.

Lomé Convention (ACP Preferences)

The EC has extended duty-free access on a non-reciprocal basis to its market as well as financial and technical assistance to 66 African, Caribbean, and Pacific countries under the third Lomé Convention (Lomé III). The agreement came into force on March 1, 1985 for a five-year period and superseded previous agreements.32 With the accession of Angola to the agreement, the signatories of Lomé III include all the sub-Saharan African countries. Lomé III contained broadly similar provisions and included an increase in EC financial assistance from ECU 5.5 billion under Lomé II to ECU 8.5 billion. A portion of the financial assistance is linked to developments in commodity export receipts of the ACP countries. In addition, the Community is committed to purchasing an agreed quantity of sugar exports at a guaranteed price. EC imports from ACP countries account for one fifth of its total imports from non-oil developing countries.

The EC is about to enter into a new round of negotiations with ACP countries to renew Lomé III after its expiry in February 1989. The EC Commission’s draft negotiating mandate, subject to the Council’s approval, includes a modification in the modalities of financial assistance to ACP countries to include loans in support of structural adjustment efforts. The negotiations are complicated by their coincidence with the Uruguay Round discussions on a possible elimination of tariffs on tropical products, which would eliminate the preferential treatment of ACP exports of such products on the EC market. Another complication is that certain ACP countries have higher per capita incomes than Greece, Ireland, and Portugal, yet rely on them for aid.

GSP Scheme

The EC’s GSP scheme provides nonreciprocal tariff concessions to developing countries. The scheme, which operates at the Community level, was introduced in 1971 and renewed in 1981 for another ten-year period. Though available to all developing countries, the GSP in practice mainly benefits Asian and Latin American countries33. Developing countries in the African, Caribbean, and Pacific regions (ACP countries), while legally beneficiaries of the GSP, enjoy more generous tariff preferences under the Lomé Convention. Similarly, most countries bordering on the Mediterranean have more favorable access to the EC market under their EC agreements than under the GSP. The scheme provides for more generous preferences for the countries appearing on the United Nations list of least developed countries, including exemptions from all quantitative limitations. Of the 39 countries on this list, all but 933 have signed the Lomé Convention and hence receive these benefits anyway.

The Community’s GSP covers all otherwise dutiable manufactured and semimanufactured products. More restrictive schemes apply to “sensitive” industrial products, including textiles and clothing. Whereas all industrial products are covered by the Community’s GSP, coverage of agricultural products is more selective.

For industrial products, quantitative limits on duty-free access are imposed on sensitive items that compete with EC products. When the limit is reached, the EC’s common external tariff is applied.34 The limit applies uniformly to each beneficiary of the scheme, except for certain sensitive products for which individualized ceilings are imposed on “competitive” exporters that are generally lower than the ceilings applied on “noncompetitive” exporters.

A more restrictive scheme is in effect for textiles and clothing. Textile imports are classified among the sensitive products and are subject to limits on duty-free access. For products covered by the Multifiber Arrangement only countries that have concluded bilateral agreements with the Community in the context of the MFA, or have similar undertakings, are entitled to benefits. All developing countries qualify for preferences on their exports of textile products that are not covered by the MFA. Individual ceilings are applied to “competitive” exporters.

Duty-free entry of nonsensitive industrial products is not subject to ceilings. If preferential imports cause or threaten to cause economic difficulties in the Community, however, the Commission can reintroduce customs duties provided an indicative threshold has been exceeded and subject to consultation with member states.35 This provision may have reduced the security of duty-free access to the EC market for GSP beneficiaries. The least developed countries are exempt from this provision.

With regard to agricultural imports, products that are subject to market arrangements under the Common Agricultural Policy and are protected by variable levies or similar devices are not covered. Obligations to ACP and Mediterranean countries also limit coverage. Concessions generally take the form of tariff reductions rather than exemptions; only one fifth of the 385 tariff lines covered enter duty free, and three products are subject to quantitative limits.

In the 1986 midterm review of the GSP, provisions were introduced to graduate country products from the EC’s scheme. Starting in 1986, countries with a per capita income exceeding $2,000 and whose share of EC industrial imports from third countries of the product concerned exceeded 20 percent were graduated from the scheme for industrial products. This provision was applied to exports from Brazil, China, Hong Kong, Korea, and Singapore. More recently, GSP benefits on all products were withdrawn from Korea on the grounds that it provides discriminatory protection for U.S. intellectual property rights. Benefits are withdrawn over two years, and the benefits withdrawn from one beneficiary are redistributed to other beneficiaries of the scheme. Starting in 1988, countries with per capita income exceeding $2,000 and whose share of EC imports of the textile product concerned exceeds 10 percent are also graduated from the textiles scheme.

Single European Market

Despite the provisions for a common market embodied in the EEC Treaty, the markets of the 12 member states do not constitute a single market for any producer or seller. Market segmentation arises from different national standards, regulatory barriers to market entry and competition, national restrictions, time-consuming internal border formalities, and discriminatory government procurement practices. Evidence of market segmentation is provided by the different prices at which identical goods are sold in member countries. This segmentation raises the cost of goods and services by creating monopoly rents, imposing administrative costs, and preventing the achievement of economies of scale, and distorts the allocation of resources within the Community (Table 15 describes selected barriers). Restrictive practices are particularly widespread in the area of services. Air, sea, and road transport, which represents more than 7 percent of the Community’s GDP, is subject to restrictions on nonresident carriers operating in member countries. In insurance, some EC members (Denmark, France, the Federal Republic of Germany, and Ireland) require that an insurance company maintain a physical presence in the country where the risk is insured. Similar regulatory barriers exist in the provision of other financial services, including restrictions on foreign acquisitions or participation in resident banks. The integration of the services markets across the Community would have important effects on their efficiency as well as on the efficiency of other sectors using these services.

Table 15.

European Community: Internal Market Program—Selected Measures

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Sources: Emerson, and others (1988); Commission of the European Communities, Bulletin of the European Communities, various issues; and Europe Information Service, European Report, various issues.

National legislation also impedes factor mobility within the Community. Licensing rules of professional associations limit the freedom of EC citizens to practice their professions in other EC states, and national educational standards have implied that diplomas are not always recognized in other member states. Similarly, most EC countries maintain capital restrictions despite a directive issued by the Commission in 1960 calling for their elimination, in line with the EEC Treaty provisions.

Single European Act

In recognition of the costs imposed by market fragmentation, the EC Council in 1985 adopted a White Paper36 containing detailed proposals to remove alt physical, technical, and fiscal barriers to free movement of goods, services, and factors of production within the Community by end-1992. The paper defines a sector-by-sector strategy and lists 300 proposals (later revised to 286) to unify the markets in member countries. These proposals were incorporated in the Single European Act that came into force on July 1,1987.37 The Act contains measures to complete the implementation of the EC Treaties but goes beyond them in certain areas.38 It thus constitutes the first major revision of the Treaties.

The Act provides for a dismantling of internal frontiers to facilitate trade within the Community. Technical barriers to trade will be gradually eliminated by applying the principle of mutual recognition of standards. However, in health, safety, consumer protection, and the environment, standards will be harmonized. Barriers to trade in services and to the movement in factors of production will be removed. Far-reaching liberalization measures are proposed in banking, insurance, security transactions, and mortgage finance. The companies providing such services will be subject to control by the authorities of the home country rather than by the authorities of the country of operation. Mortgage credit institutions will be allowed to operate freely with other member countries and offer mortgages patterned on their home country regulations. The system of quotas in road and air transport will be gradually phased out. Public procurement will be open to Community-wide bidding. EC citizens will have freedom to engage in their professions throughout the Community, and all capital controls will be lifted.

Fiscal barriers would be removed “by approximation” (as opposed to equalization) of indirect taxes (value-added taxes) in member states. The system would resemble the U.S. system, in which interstate borders do not exist and variations in tax rates among states are limited within a band to avoid encouraging interstate trade based on differences in indirect tax rates.

An important companion measure to the internal market program was the doubling of the EC structural funds—the regional and the social funds—to compensate the Community’s less prosperous regions for the intensified competition that would result from the single market. In the lower-income countries at the Community’s periphery—Greece, Ireland, and Portugal—the entire territory is considered to be made up of less prosperous regions. The compensation was agreed to, notwithstanding some studies showing that these countries would benefit the most from the dismantling of internal barriers because their geographical location implied that they had more barriers to cross compared with more centrally located EC countries.39 Greece and Spain would benefit from the Integrated Mediterranean Programs that are part of the planned increase in the EC’s structural funds. The loans would finance infrastructure projects, professional training, productive investment, and productivity improvements in both the private and public sectors under a program (rather than project) approach designed to broaden regional objectives further. These loans would include a grant element.

Implementation of the Act

To facilitate the adoption by member states of the proposals contained in the White Paper, the Single European Act amended the EEC Treaty by extending the areas in which decisions could be adopted by simple or qualified majority in the EC Council. The adoption of most measures concerning the establishment of the single market therefore does not require unanimity.40

Implementation of the proposals contained in the White Paper was initially slow, but was accelerated under the German presidency of the EC Council in the first half of 1988. Reform has also acquired a momentum of its own as the proposed deregulation of certain sectors (e.g., the financial sector) has created pressures for deregulation in other areas (e.g., liberalization of capital movements). As of June 1988, about one third of the 286 proposals were fully adopted by member states, a few were partially adopted, and the remaining are pending. Most of the proposals adopted deal with the removal of physical and technical barriers, the liberalization of transport and financial services, the enhancement of labor mobility, and the lifting of capital controls. The remaining deal with the introduction of new technologies, company law, intellectual property rights, and fiscal barriers. Table 15 provides details of selected decisions and their impact.

The most significant progress has been made in removing capital controls,41 enhancing labor mobility through mutual recognition of university diplomas, liberalizing road transport, harmonizing technical standards affecting pharmaceutical products, and reducing customs formalities. The introduction of the Single Administrative Document in January 1988 superseded some 70 customs documents in several different languages. Progress in air and sea transport, broadcasting, banking, and securities trading has been slower.

Studies of Effects

The potential economic impact of completing the internal market by 1992 was evaluated in a recent study.42 The study assumed that barriers against the rest of the world do not increase and concluded that completion of the single market could provide gains of about ECU 200 billion, equivalent to 5 percent of Community GDP, and increase employment by 1.8 million over the medium term (Table 16). If EC governments used the room created by the release of productive resources to pursue expansionary policies simultaneously, GDP could increase by 7 percent and employment by 5 million. Broadly similar estimates of the potential gains from a single market were presented in a recent Data Resources, Inc. study.43

Table 16.

European Community: Macroeconomic Consequences of Completion of the Internal Market

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Source: Emerson, and others (1988).

In thousands.

In percent of GDP.

This scenario assumes that accompanying macroeconomic policy measures exploit 30 percent of the room for maneuver created by the fall in consumer prices and the reduction in the fiscal deficit.

Assumes budgetary expansion to exploit the entire room for maneuver created by the fall in prices and the reduction in the fiscal deficit.

Assumes budgetary expansion up to the point where the Community’s external balance is left unaffected by the creation of the single market.

The assessment of the effects of completing the internal market was based on simulations using econometric models.44 The simulations cover four aspects of market unification—removing internal frontiers, opening up public procurement, liberalizing financial services, and supply effects. The supply effects analyzed include the direct costs of technical and regulatory barriers that limit market entry and competition, whose removal would reduce monopoly rents and enable firms to achieve economies of scale. Supply effects were estimated to be the single most important source of gain from market unification. These effects may be underestimated because they do not take account of the effects of competition on innovation and technical change. In addition, completion of the internal market is expected to ease the macro-economic constraints on the Community. The consequences of the internal market could thus be further magnified by accompanying macroeconomic policies that utilize the room created by the release of productive resources. The study explores three alternative scenarios involving budgetary expansion in the Community to exploit all or part of the easing in the external constraint caused by the fall in prices and the reduction in public deficits. The resulting increase in GDP ranges between 6½ percent and 7½ percent, depending on the amount of stimulus provided. In practice, these additional gains may arise from supply effects that raise investment demand by increasing the after-tax return on capital, dispensing with the need for fiscal expansion.

External Effects and Interaction With the Uruguay Round

In principle, the internal market program consists of a set of microeconomic supply-side measures intended to be neutral with respect to the rest of the world. In practice, adherence to the principle of neutrality is not automatic and, in some cases, is impossible. The completion of the internal market is thus likely to affect third countries.

The net impact on third countries will depend on the balance of the single market’s trade-creating and trade-diverting effects, which, in turn, depends in part on the Community’s external regime after 1992. In some cases, internal liberalization measures will become automatically available to third countries or will change the Community’s regime with the rest of the world. In the latter, the Community would liberalize vis-à-vis the rest of the world unless it makes adjustments to its external regime. For the most part, decisions to determine the Community’s external regime have not yet been taken.

Many of the measures to complete the internal market are in areas subject to negotiations within the Uruguay Round. These include “new areas,” such as services, trade-related investment measures, and trade-related aspects of intellectual property rights, as well as other areas such as government procurement and technical barriers to trade. Other areas in which decisions are necessary to determine the EC’s external regime after 1992 are also subject to negotiation in the Uruguay Round. Most notable among these are gray-are a measures maintained by individual EC members. The Uruguay Round thus offers scope to obtain parallel market-opening measures on a multilateral basis. The EC is also exploring opportunities for parallel market-opening measures on a bilateral basis with other countries or trading groups.

Measures contained in the White Paper can be divided into five groups to illustrate the options available to the EC as it completes the internal market:45

  • The EC opens internally without any external impact. Indirect tax harmonization and the elimination of internal frontiers are examples of such measures.

  • The EC opens “erga omnes,” internally and externally in one and the same action. The liberalization of capital movements is an example of such a measure. Internal liberalization in this area is akin to a public good.

  • The EC opens internally with possibilities for parallel opening measures multi late rally in GATT, or bilaterally with other countries or trading groups. Examples include government procurement, where the GATT code is under discussion in the Uruguay Round.

  • The EC opens internally and, in doing so, necessarily changes its regime with the rest of the world. The existence of internal borders at present permits the enforcement of restrictions on imports of automobiles and other products and individual EC member country quotas agreed under the Multifiber Arrangement. With the removal of internal borders in 1992, national restrictions will need to be lifted or replaced by EC-wide restrictions.

  • The completion of the internal market also raises the issue of “nationality’’ of EC and foreign firms with regard to establishment, mergers, and takeovers. Increased barriers in this area would result if regulations applying to non-EC firms were more restrictive than those applying to EC firms. It would be akin to an increase in trade-related investment barriers.

The external impact of internal liberalization clearly depends on decisions to be taken by the EC on the extent to which internal liberalization is extended to third countries, either unilaterally or through reciprocal market-opening measures. A liberal policy approach by the EC would benefit the EC as well as third countries. While the EC has stated that it does not intend to increase external restrictions, disparities in national levels of protection and competitiveness in particular sectors have given rise to pressures for the adoption of the most restrictive national regime by the EC as a whole. For example, automobile manufacturers in countries that maintain national VERs are resisting the possible elimination of these barriers. In particular, they argue that increased access to the Japanese market as measured by target market shares is a condition for the removal of these restrictions. More generally, the extent to which the benefits of the integrated market will be extended to third countries will depend on reciprocal market-opening measures by the EC’s major trading partners. The EC is pursuing such market-opening measures both bilaterally and in the context of the Uruguay Round. Finally, the benefits to the EC of a liberal policy will act to counter protectionist pressures.

Implications for Other European Countries

The recent initiatives toward integration of the EC internal market gave new impetus to bilateral discussions between the EC and EFTA countries and raised the issue of EFTA countries’ membership in the EC.46 Discussions on possible areas of increased EC/EFTA cooperation are progressing. As noted, EFTA countries are apprehensive that their access to the EC market will be reduced as a result of the internal market and that important decisions (for example, on EC standards) will be taken without their input.

Some EC members, and in particular the Mediterranean countries, have taken the view that the benefits of the internal market should not be extended to EFTA countries without “payment.” The payment could take the form of EFTA contributions to the EC’s structural funds, improved access to the EFTA markets for agricultural commodities of Mediterranean countries, or relaxing restrictions on labor mobility. These proposals are resisted by other EC countries that do not want the entire Community to bear the burden of concessions that benefit only the Mediterranean countries. Making the payment proposal workable would thus require finding ways to share the EFTA payment more equitably among EC members. A separate issue is whether the EC should negotiate access to the EC market with EFTA on a bilateral basis, or multilaterally in the Uruguay Round. The latter option would reduce the scope for further fragmenting the world trading system into regional trading blocs.

1

The EC comprises three Communities: the European Coa1 and Steel Community (ECSC), governed by the Treaty of Paris, and the European Economic Community (EEC) and the European Atomic Energy Community (EURATOM), governed by the Treaties of Rome. The institutions of the three Communities were merged in 1965 and are henceforth referred to as the European Community (EC).

2

Belgium, France, the Federal Republic of Germany, Italy, Luxembourg, and the Netherlands.

3

The effects of the CAP are discussed in Rosenblatt and others (1988). See also Section V.

4

This Appendix covers trade-related aspects of Community-wide regulations on industrial policies and their implementation.

5

Austria, Iceiand, Norway, Sweden, Switzerland, and, since 1986, Finland, Denmark, Portugal, and the United Kingdom were EFTA members before joining the EC.

7

Belgium, Denmark, France, the Federal Republic of Germany, Ireland, Italy, Luxembourg, and the Netherlands.

9

VERs include bilateral quotas, unilateral monitoring, and minimum price undertakings. These measures are applied on a discriminatory basis and are referred to as gray-area measures because their conformity with GATT is unclear.

10

Excluding arrangements that existed prior to 1988 but were reported by GATT only in 1988, the number of VERs increased by about 40 percent in the EC, compared with 65 percent in the rest of the world.

11

The restrictions by France and the United Kingdom are industry-to-industry agreements and are not approved by the Commission. The restriction by Italy is approved by the Commission. It originated from a reciprocal self-restraint arrangement concluded in the 1950s and was initially intended to protect the Japanese market against imports of Italian cars. The restrictions limit imports to 3,425 units (Italy), 3 percent of estimated domestic demand (France), and 11 percent of estimated U.K. sales (United Kingdom).

12

Other major industrial countries also maintain residual restrictions.

13

The EC is a signatory to the Tokyo Round Code on Import Licensing.

14

Licensing systems applied by individual members of the EC are described in International Monetary Fund (1988a).

15

The definition of subsidies in the EC’s countervailing legislation is based on the existence of a direct financial contribution by governments, in contrast to the U.S. legislation, which is based on a broader definition.

16

Data provided by GATT.

17

International Monetary Fund (1988a). The report includes for the first time an Annex of measures taken by the EC in 1987.

18

The Airbus Consortium is also affected by the GATT Code on Trade in Civil Aircraft. The dispute on the financing of aircraft construction between the United States and the EC is covered in Section VI.

19

The reporting requirements on state aids cover areas exceeding the jurisdiction of the Commission.

20

Remaining production quotas and guide prices applicable to steel were lifted following an EC Council decision in June 1988 (see Section VI).

21

Belgium, France, the Federal Republic of Germany, Portugal, Spain, and the United Kingdom have coal mining industries.

22

Last January, the Commission approved a package of subsidies to the German coal sector amounting to DM 4.2 billion in 1988.

23

The EC provides information to the Organization for Economic Cooperation and Development (Working Party 6) that is used to monitor developments in shipbuilding.

24

The margin of interest rate subsidy below that permitted in the Consensus Arrangement does count against the ceiling.

25

Recent examples involve Renault (France) and Rover (the United Kingdom). The case of Renault involved also loan writeoffs of F12 billion, which were sanctioned by the Commission provided no further aid is granted, its restructuring program is fully implemented, and its status changed from a state agency (Régie), whose debts are guaranteed by the Government, to a normal commercial company.

26

Article 93(2) permits the Commission to refer the matter directly to the European Court of Justice if the aids are not rolled back within the prescribed time.

27

The agreements allowed for a transition period until 1976 but were not fully implemented until 1984 because Finland had longer transition periods on a number of sensitive products.

28

These affect a few products, including copper scrap, representing a negligible amount of EFTA/EC trade.

29

Currently duty-free access is granted by the EC on products with value added of at least 60 percent in any individual EFTA country.

30

The EC undertook to help GCC countries diversify their energy, industrial, and agricultural sectors through joint ventures, technology transfers, training, and joint surveys of markets for oil and gas and their derivatives.

31

Most-favored-nation treatment presently does not apply to trade between the EC and the GCC countries that are not GATT members; Kuwait is the only GATT member.

32

The Yaounde Conventions I and II (1964 and 1971) with African countries were replaced by Lomé I (1976), which included 21 former Commonwealth countries that were invited to join following the United Kingdom’s entry into the EC. A successor agreement, Lomé II, was signed in October 1979, a few months before Lomé I expired. Lomé II broadened the scope of the agreement to include provisions relating to payments and capital movements, direct investment, and services. Grants and loans were provided through the EC budget and the European Investment Bank.

33

Afghanistan, Bangladesh, Bhutan, Haiti, Laos, Maldives, Nepal, Yemen Arab Republic, and Yemen People’s Democratic Republic.

34

The limited duty-free access applied to imports of petrochemicals has given rise to a dispute between the EC and the GCC countries.

35

The Commission has received an increasing number of requests to reintroduce duties on nonsensitive products in recent years. In 1987, duties were reimposed in 19 cases covering 18 products, 12 of which were chemical products.

38

For instance, the Council’s voting procedures.

40

Unanimity would still be required in decisions pertaining to harmonization of turnover taxes, excise duties, and other forms of indirect taxation.

41

Discussions are underway to ensure that divergent tax rates do not distort the allocation of capital among member countries.

43

Data Resources, Inc. (1987/88). The DRI estimates are not strictly comparable with Emerson, and others (1988), insofar as they analyze only the short-term effects of harmonizing VAT and scrapping border controls.

44

The Commission’s Hermes model and the OECD’s Interlink model.

45

This classification was suggested by the Commission.

46

One of the issues for certain EFTA members is whether joining the EC is compatible with maintenance of political neutrality, given the Community’s common foreign policy.