Economic Policy in the European Union

Economic Policy in the European Union

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Economic Policy in the European Union Sixten Korkman Director General for Economic and Social Affairs General Secretariat of the Council of the European Union Brussels

Sixten Korkman 2005 Softcover reprint of the hardcover 1st edition 2005 978-1-4039-4344-6 The views expressed in this book are those of the author, not of the institution to which he is attached. All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2005 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N. Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin s Press, LLC and of Palgrave Macmillan Ltd. Macmillan is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN 978-1-349-52206-4 ISBN 978-0-230-51129-3 (ebook) DOI 10.1057/9780230511293 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Korkman, Sixten, 1948 Economic policy in the European Union/Sixten Korkman. p. cm. Includes bibliographical references and index. 1. European Union countries Economic policy. 2. European Union countries Economic conditions. I. Title. HC240.K728 2004 339.5 094 dc22 2004052097 10 9 8 7 6 5 4 3 2 1 14 13 12 11 10 09 08 07 06 05

To Marit

Say what you want about the music of Wagner, but you have to admit that it is actually much better than it sounds. Mark Twain

Contents Boxes Figures Tables Abbreviations Acknowledgements Preface ix x xi xii xiv xv 1 Introduction 1 1.1 The basis of economic policy 1 1.2 The essence of the EU 10 2 Rationale 18 2.1 Interdependence and the common interest 18 2.2 Subsidiarity 27 2.3 Economic objectives in the treaty 28 2.4 The EU as an economic policy regime 29 3 Methods 32 3.1 Intergovernmental cooperation versus 32 supranational action 3.2 Collective choice with unanimity 34 3.3 Collective choice and majority voting 39 3.4 QMV with safeguards 46 4 Modalities 48 4.1 Community institutions and bodies 48 4.2 Competence and assignment 54 4.3 Methods of Community involvement in economic 56 policy decision-making 4.4 Voting rules and weights 59 4.5 Instruments and procedures of economic policy 62 coordination Annex: the preparatory machinery and decision procedures 67 5 Macroeconomic Policy in the SOE 71 5.1 The SOE-model 72 5.2 The SOE-model revisited 82 Annex: fiscal policy in the SOE 86 vii

viii Contents 6 Macroeconomic Policy in the EMU 89 6.1 Cross-border effects in a monetary union 90 6.2 The case for policy coordination 95 6.3 The adjustment process 101 6.4 Does EMU need a stabilisation fund? 106 6.5 Debt dynamics and the SGP 110 6.6 The case for policy assignment 119 Annex: policy coordination in EMU 121 7 Structural Policies 125 7.1 The internal market 125 7.2 Financial services and markets 132 7.3 Labour markets and social policy 139 8 Tax Policy 146 8.1 Taxes and sovereignty 146 8.2 Indirect taxes 148 8.3 Direct taxes 152 9 The Community Budget 165 9.1 Negotiating the Community budget 165 9.2 Community tasks and expenditure 167 9.3 Financing the Community budget 173 10. Problems and Prospects 176 10.1 Economic performance 177 10.2 Economic governance 187 Notes 199 References 207 Index 212

Boxes 1.1 The state as a cooperative solution 3 1.2 The EU defined 14 2.1 William Penn and peace in Europe 19 2.2 The case for policy cooperation 21 3.1 Tax policy and milk quotas 38 3.2 Condorcet s paradox 42 4.1 ECB independence 53 4.2 The SGP and the EDP 64 4.3 The BEPGs and the coordination process 66 4.4 Legal instruments in the EU 68 5.1 The OCA literature 81 6.1 Ready reckoners 93 6.2 The ECB definition of price stability 106 6.3 An aside on structural policies 109 6.4 The difficulty of living with rules 117 7.1 The pension problem 144 8.1 Capital taxation and agglomeration effects 157 9.1 Cohesion policy 171 ix

Figures 2.1 The case for policy cooperation 21 3.1 Majority voting and redistribution 35 3.2 The optimal majority 39 3.3 Sequential majority decisions 43 3.4 Problems of majority voting 45 4.1 Economic policy in the EU: who does what? 51 4.2 The BEPGs 66 4.3 The Council s preparatory machinery 69 5.1 Macroeconomic policy in the MF-model 75 5.2 EMU and openness 81 5.3 Exchange rate overshooting 85 6.1 Taxonomy of policy coordination 98 6.2 The adjustment process 102 6.3 Deflationary dilemma 103 6.4 Adjustment with price rigidity 105 6.5 The benefits of a stabilisation fund 107 6.6 Public finance sustainability 112 6.7 Output stabilisation and the budget balance 115 7.1 Market integration 127 7.2 The regulatory framework of the internal market 131 8.1 The destination principle (VAT rates) 149 8.2 Capital taxation and integration 154 8.3 Capital taxation in the SOE 156 8.4 Capital taxation and increasing returns 157 10.1 Benefits of Community action 193 10.2 Costs and benefits of Community action 194 x

Tables 1.1 The prisoners dilemma 3 1.2 Rationale of economic policy 7 2.1 Rationale of policy cooperation 24 3.1 Logrolling 40 3.2 The voting paradox 42 4.1 Economic policy in the EU: who does what? 57 4.2 Voting weights in the EU 61 6.1 Comparative statics in EMU 92 6.2 Effects of fiscal and monetary policies in the euro area 93 9.1 Community expenditure, budget 2004 168 9.2 Community revenues, budget 2004 174 10.1 Stability 178 10.2 Macroeconomic policy 179 10.3 Long-term growth 182 10.4 GDP per capita in the EU relative to the USA 183 10.5 Employment rates 184 10.6 Relative performance of member states 186 (structural indicators) xi

Abbreviations BEPG CAP CEPR CFSP COREPER ECB ECJ ECSC EDP EEC EFC EFSA EFTA EIB EMU EP EPC ESCB FP GDP GNI HST IGC IIA IMF KIP LDCs NCB OECD OCA OMC OR PPS QMV SEA SGP Broad Economic Policy Guidelines Common Agricultural Policy Centre for European Policy Research Common Foreign and Security Policy Committee of Permanent Representatives European Central Bank European Court of Justice European Coal and Steel Community Excessive Deficit Procedure European Economic Community Economic and Financial Committee European Financial Supervisory Authority European Free Trade Area European Investment Bank Economic and Monetary Union European Parliament Economic Policy Committee European System of Central Banks Financial Perspective Gross Domestic Product Gross National Income Home State Taxation Intergovernmental Conference Interinstitutional Agreement International Monetary Fund Key Issues Paper Least Developed Countries National Central Bank Organisation for Economic Cooperation and Development Optimum Currency Area Open Method of Coordination Own Resources Purchasing Power Standards Qualified Majority Voting Single European Act Stability and Growth Pact xii

Abbreviations xiii SME SOE TARGET TEN UN VAT WP WTO Small and medium-size enterprise Small Open Economy Trans-European Automated Real-time Gross Settlement Express Transfer system Trans-European Network United Nations Value Added Tax Working Party World Trade Organization

Acknowledgements The author and publishers are grateful to the following for permission to reproduce copyright material: the Organisation for Economic Cooperation and Development for data from OECD Economic Outlook, December 2003; A. Sapir and Oxford University Press for data from An Agenda for a Growing Europe, 2004; the copyright section of the European Communities for data in various figures and tables in the book; John Harper Publishers for much of the material in Chapter 4 from M. Westlake and D. Galloway, The Council of the European Union, 2004. xiv

Preface European countries are close to each other geographically and politically; their economies are integrated and interdependent. National policies have significant cross-border effects on neighbouring countries, and the spillovers risk giving rise to distortions and tensions. Cooperative action at the European level is needed in order to avoid conflicts and to achieve efficiency. The European Union manages interdependence of member states by articulating and enhancing common interests through collective action, including common policies and joint governance within a framework of supranational institutions. This endeavour faces considerable hurdles in the form of practical difficulties and political sensitivities. Many of the features of the EU can be understood only in the light of a fundamental ambivalence in public attitudes towards European integration: the crossborder effects and common interests are acknowledged (if understood), but citizens sentiments of identity, loyalty and solidarity continue to have a strongly national orientation. Member states are hesitant or unwilling to relinquish national control in favour of Community institutions, unless the powers of the Community are ring-fenced and/or unless their exercise remains subject to sufficient national influence. There is a constant need to make the case for Europe, and to make it in comprehensible language and with clear arguments. The EU is, as has often been pointed out, an economic giant but a political dwarf. Also, it is institutionally complex and there is more than one truth about the EU. It may be portrayed as a supranational bureaucracy geared to undemocratic and intrusive action. It can also be perceived as an innovative system which in subtle ways has succeeded in surmounting the antagonistic barriers associated with national frontiers and thereby in safeguarding peace and prosperity in Europe. There are pronounced differences of view not only with regard to what the EU is but even more so with regard to how it should develop and what it should become. This book attempts to understand and assess the EU in general and its economic policy regime in particular. It examines the logic of collective action with a view to answering the two-fold question: when is collective action called for? (as compared to leaving matters to private initiative and markets); and when is supranational action needed? xv

xvi Preface (that is, a transfer of discretionary political power to the Community level) as compared to leaving matters to national governments and intergovernmental cooperation? The rationale of the EU can be clarified only by examining and answering this two-fold question and the book sets this out in general terms (Chapters 1 and 2), in the context of macroeconomic policies (Chapters 5 and 6), structural policies (Chapter 7), taxation (Chapter 8) and the Community budget (Chapter 9). It also examines the differences between intergovernmental and supranational action (Chapter 3), describes the institutional set-up of the EU (Chapter 4), and makes some comments on key aspects of the EU s economic performance and its system of governance (Chapter 10). In writing the book, I have tried to give due attention to the different perspectives that are necessary to understand the role and functioning of the Community. The policy issues are examined in terms of economic theory, drawing notably on the macroeconomic theory of open economies as well as on public sector economics and the theory of public choice (the economic analysis of political behaviour). The legal and institutional framework of the EU is described in some detail, and problems are in many instances illustrated by historical episodes and events that are of interest not only in themselves but also because they highlight issues of principle. A broad approach is needed because a good understanding of the problems and prospects with which economic policy in the EU is confronted requires a multiple perspective, one that combines analysis of economic and political principles with considerations reflecting the institutional reality of the Community and practical experience of its decision-making. Upon arrival in Brussels in 1995, I was overwhelmed by the complexity and the opacity of the European Union s system of economic governance. That I should write a book to clarify my thoughts was first suggested by my former assistant, Marisa Penocchio, who did much to help me understand the modus operandi of the Council. I am grateful to her and to her successor, Alexandra Almeida, as well as to collaborators who have checked various parts of the text (including Andrew George, Bodil Nielsen, Ilkka Saarilahti, Servatius van Thiel and Kyle Galler). Chapter 4 is based on my contribution to Westlake and Galloway (2004); permission to reproduce that material is gratefully acknowledged. While most of the book can be read without any training in economics, some familiarity with elementary macroeconomics should facilitate the reading of Chapters 5 and 6. It goes without saying that the responsibility for the views expressed in this book, and for remaining errors, is mine and mine alone. SIXTEN KORKMAN