a2 econ european union

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Teacher presentation A2 Econ Unit 4 European Union


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Slide 1:

The UK and the European Union Chapter 19

Slide 2:

Introduction The UK has been a member of the European Union since January 1973 Well over half of its trade in goods and services is with our partners inside the EU The activities, policies and spending of the EU are financed largely through its own resources In 2005, Germany, France, Italy and the UK were the largest contributors to the budget Germany contributed 23% of the total, France 18% and the UK 12% The UK is a net contributor to the EU budget; it pays in more than it receives in allocated spending

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Customs Union The European Union is a customs union which comprises two or more countries which agree to: Abolish tariffs and quotas to encourage free trade . For example products that originate in the EU circulate duty-free they might still be subject to charges such as VAT Adopt a common external tariff (CET) on imports from non-members countries In the case of the EU the tariff imposed on imports of South Korean digital cameras will be the same in the UK as in France or Hungary A CET prevents individual countries imposing their own unilateral tariffs that differ from other in the customs union A customs union shares the revenue from the CET in a pre-determined way – in this case the revenue goes into the main EU budget fund.

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World Trade Organisation (WTO) The EU is a member of the World Trade Organisation Officially it subscribes to its free trade ethos especially where this is to the advantage of the EU For example the EU is ready to use the WTO appeals mechanism in its frequent disputes with the USA and also with China The EU itself has been the subject of several cases brought by other nations to the WTO Examples include the recent increase in the import tariff on bananas which was subject to a WTO challenge brought by Ecuador in November 2006 the dispute between the EU and the WTO on reforms to the EU sugar regime.

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The EU Single Market The European Union seeks to develop a single market for goods and services across all member nations At the heart of the concept of a single market are four freedoms Free Trade in Goods: Businesses can sell their products anywhere in the EU‘s member states and consumers can buy where they want with no penalty. Mobility of Labour: Citizens of EU member states can live and work in any other country and their professional qualifications should be recognised. Free Movement of Financial Capital: Currencies and capital can flow freely between member states and EU citizens can use financial services in any member state. Free Trade in Services: Professional services such as banking, insurance, pensions, architecture, telecommunications and advertising can be offered in any member state.

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The EU Single Market To draw from game theory the EU Single Market seeks to be a positive sum game for member states If trade and competition enhances productivity and reduces costs and prices, there are positive effects for both consumers and businesses Lower prices should boost consumers' real living standards and an increase in competition will lead to improved allocative efficiency The enormous size of the Single Market might also allow businesses to exploit economies of scale and scope leading to improvements in productive efficiency There are gains from a freer movement of labour

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Enlargement of the EU Single Market The expansion of the EU to embrace more countries has been perhaps the most important development in many years Since 1957 then there have been six main waves of enlargement the latest of which occurred in January 2007 The result has been a widening of the single European market How much further can the process of enlargement go? Is there a danger of enlargement fatigue? What is certain is that the expansion of the EU is having dynamic economic, social and political effects that will be seen for decades to come. 1973 (UK, Ireland and Denmark) 1981 (Greece) 1986 (Portugal and Spain) 1995 (Austria, Finland and Sweden) 2004 (Accession of ten new members – Latvia, Lithuania, Cyprus, Malta, Slovenia, Slovakia, Estonia, Hungary, Czech Republic, Poland) 2007 (Accession of Bulgaria and Romania)

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Advantages of EU enlargement for the UK Export Potential There are trade creation effects from increasing the size of a customs union Britain for example should now be able to source some of her imports more cheaply leading to an improvement in her terms of trade The efficiency of the economy should increase as resources are diverted to areas of the UK‘s comparative advantage Exploitation of economies of scale from supplying to a larger market As the size of the European market increases and accession countries become richer creating new demand for goods and services.

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Advantages of EU enlargement for the UK Foreign Investment and Incomes and Profits Foreign investment by British firms into Europe‘s new states will provide a flow of interest profits and dividends thereby boosting our GNP and supporting the current account of the balance of payments FDI will also help to speed up the economic transformation of Europe‘s new countries. A more diverse European labour market There are now greater opportunities for British businesses to import lower-cost skilled labour in areas where there are labour shortages The migration of labour from accession countries may help to offset in part some of the longer-term effects of ageing populations and the slow growth of the population of working age.

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Risks of EU Enlargement for the UK Extra budgetary costs for financing EU programmes – most of the new member states of the EU are relatively poor in terms of real GDP per capita. Social and economic pressures from net inward migration Shift of foreign direct investment and jobs to eastern Europe – partly driven by tax competition Political impact of a wider Europe

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European Monetary Union Britain remains outside of the single European currency and there is little likelihood of the country opting to join the Euro in the near future.

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The European Central Bank The European Central Bank is responsible for setting monetary policy for Euro Zone countries Each country retains its own central bank but they do not have monetary policy power As of January 2010 there are 17 nations within the Euro Zone The European Central Bank (ECB) is in charge of setting a common interest rate for the Euro Zone countries Their objective is to achieve price stability defined as a year-on-year increase in consumer prices of 2% The ECB does not currently have an exchange rate target although it has intervened on a few occasions to influence the external value of the Euro in the global currency markets day-to-day the value of the Euro against say the US dollar or the pound is left free to float on the markets.

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The Convergence Criteria for joining the Euro Countries wishing to join the single currency must meet four convergence criteria . Stable prices : Inflation must not be more than 1.5 per cent higher than the average in the three member countries with best price stability, i.e. lowest inflation. Stable exchange rate : The national currency must have been stable relative to other EU currencies for a period of two years prior to entry into the monetary union Sound government finances : Total government debt must not exceed 60 per cent of GDP. The annual government budget deficit must not be greater than 3 per cent of GDP. 4. Low interest rates : The 5-year government bond interest rate must not be more than 2 percentage points higher than in the three member countries where inflation is lowest.

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The Main Arguments for the UK Joining the Euro The main justifications for the UK participating in the single currency are as follows: Trade and productivity Euro membership might enhance UK productivity by increasing trade between it and other EU nations Trade provides a competitive stimulus to businesses and this could help to raise productivity levels. Price transparency Membership of the Euro makes it easier for consumers and businesses to compare relative prices between countries There are gains to be had in consumer welfare if price transparency leads to improvements in allocative efficiency.

Slide 16:

The Main Arguments for the UK Joining the Euro The cost of doing business in Europe Joining the Euro would reduce exchange rate uncertainty for UK businesses and also lower transactions costs for companies, consumers and tourists Over 60% of its trade in goods and services is conducted with other members of the European Union; the cost savings might be substantial. Foreign investment Britain has been a major recipient of foreign direct investment (FDI) in recent years Some commentators believe this would be threatened if the UK remains outside the system over the long term By removing a currency barrier to trade membership of the Euro could also facilitate the development of UK-owned multinational enterprises.

Slide 18:

Arguments against the UK Joining the Euro Risk of deflation Currency unions have collapsed in the past and there can be guarantees that monetary union will prove to be a success It may indeed turn out to be a recipe for economic stagnation if the ECB sets interest rates too high to keep inflation within the 2% target. Problems in setting interest rates In a currency union comprising many countries it is impossible for interest rates to be at a level than is optimum for any one country Giving up freedom to set interest rates Joining a single currency reduces Britain‘s freedom to set her own interest rates based on her own macroeconomic objectives. Tying the hands of government? Remaining outside the Euro Zone gives the UK a degree of fiscal policy freedom not available fully to Euro Zone member states.

Slide 19:

Arguments against the UK Joining the Euro Imbalances in response to interest rate changes There is evidence that the British economy may be more sensitive to the effects of interest rate changes than other EU countries In part this is because of the high level of owner-occupation in the housing market on variable-rate mortgages. The cost of making the change The change-over process to having the Euro will involve substantial menu costs for businesses and banks These menu costs night bear most heavily on smaller and medium sized enterprises Consumers fear that the change-over period would encourage some unscrupulous businesses to raise prices to take advantage of consumer confusion. Would the ECB do better than the Bank of England The Bank of England‘s success in keeping inflation within target and at the same time changing interest rates to keep the economy on track for sustained growth, may have undermined the case for UK entry into the Euro Zone Would macroeconomic performance under the ECB be noticeably better?

Slide 20:

Optimal Currency Areas An optimal currency area (OCA) is a geographical region where it is thought a single currency would help to maximise economic welfare An OCA does not have to be larger than one country for example one might argue the case for regional currencies e.g. between the north and south of the UK or between the east and west of the USA An OCA tends to work best when the countries within it are already highly integrated with each other and where each has a sufficiently flexible labour market to cope with unexpected external economic shocks such as rising oil prices or a major demand-side shock in the world economy The OCA is also likely to work well when the impact of interest rate changes have a broadly similar effect on businesses and households from country to country

Slide 21:

Optimal Currency Areas In most important respects, the Euro Zone of fifteen countries is not close to being an OCA although a small group of countries within it are probably closely convergent in a structural sense An OCA is better placed to succeed with a small cluster of countries rather than the coalition of thirteen nations that count themselves as founder members of the single currency One of the obvious reasons why the Euro Zone is not an optimal currency zone is because of labour immobility It is well known that Europe does not have a mobile labour force Not only is there little migration between European countries in response to an economic shock there is little migration between regions within a single country Such immobility may arise because of language, cultural or cost barriers including the effects of wide variations in property prices and the cost of living.

Comparing the economic performance of the UK and the Euro Zone:

Comparing the economic performance of the UK and the Euro Zone

Slide 23:

Comparing UK and Euro Zone economic performance When considering the numbers in the previous table be aware that the Euro Zone is made up of fifteen countries and that the individual performance of countries that have adopted the single currency can be markedly different from the average record for the currency union The following can be observed The UK has enjoyed relatively stronger growth – averaging half a per cent faster. Much of this has been driven by increases in consumer spending. The UK has enjoyed persistently lower unemployment over the period although the gap between the UK and the Euro Zone has been closing Unemployment is expected to rise throughout the European economy for the rest of 2008 and into 2009.

Slide 24:

Comparing UK and Euro Zone economic performance The UK has experienced a much higher budget deficit – averaging more than 3 per cent of national income and the current account balance (the balance of trade in goods and services, net investment income and transfers) has also been persistently in the red. Consumer price inflation has been marginally lower in the UK but both areas have seen a rise in inflation. inflation in the Euro area reached an eleven year high at the end of 2008. Despite having lower inflation overall, official short term interest rates have been higher in the UK.

Slide 29:

Why different interest rates? The UK and the Euro Zone share a common inflation target – inflation of two per cent – yet we see a consistent difference between interest rates. Why is this happening? The main reason for the divergence in interest rates is that each central bank has a different view of the risks of cost push and demand pull inflation. Historically inflation has been more of a problem for Britain than it has for continental economies of Western Europe especially Germany. Short term interest rates are often a clear guide to official expectations of inflation The Bank of England has done a good job since 1997 of keeping inflation down and allowing the UK economy to grow, but there remains, underneath the surface, a fear of a return to higher wage inflation and some concern that rapid asset price inflation especially in the housing market could lead to too fast a growth of consumer borrowing and spending. A neutral level of interest rates for the UK i.e. a rate of interest that is neither deliberately seeking to expand spending or contract it is probably around 5% for the UK and a little lower in the Euro Zone

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