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Student Edition
Instructor Edition
The Economics of European Integration, 3/e

Richard Baldwin
Charles Wyplosz

ISBN: 0077121631
Copyright year: 2009

Book Preface



European integration keeps amazing its supporters and critics alike. No other region has displayed similar willingness to jettison important components of sovereignty in pursuit of shared, yet thoroughly imprecise, goals. And, in its own peculiar way, European integration keeps forging ahead at a pace that is too fast for some and too slow for others. No one would deny, though, that the transformation of the past half century is spectacular – a clean break with centuries of intra-European warfare. This integration is clearly important for the 500 or so million Europeans it directly affects, but since Europe accounts for one-quarter of the world economy, half of world trade and one-third of world capital markets, European integration also affects the lives of most non-Europeans.

A subtle interplay of strictly economic and much broader, high-minded goals has driven European integration forward along political, cultural and economic dimensions. The goal of this book is to provide an accessible presentation of the facts, theories and controversies that are necessary to understand this process. Our approach is rooted deeply in economic principles for the simple reason that economic integration has been the vanguard since the Organisation for European Economic Cooperation was founded in 1948. Yet economics is not enough; historical, political and cultural factors are brought into the picture when necessary.

What this book is

This is a textbook for courses on European economic integration. Its emphasis is on economics, covering both the microeconomics and macroeconomics of European integration. Understanding European economic integration, however, requires much more than economics, so the book also covers the essential aspects of European history, institutions, laws, politics and policies.

The book is written at a level that should be accessible to second- and third-year undergraduates in economics as well as advanced undergraduates and graduate students in business and in international affairs, European studies and political science. Some knowledge of economics is needed to absorb all the material with ease – a first-year course in the principles of economics should suffice – but the book is self-contained in that it reviews all essential economics behind the analysis. Diligent students should therefore be able to master the material without any formal economics background.

What is in this book.

The book is organised into five parts: essential background (Part I), the microeconomics (Part II) and macroeconomics (Part III) of European integration, and microeconomic (Part IV) and macroeconomic (Part V) policies).

Part I presents the essential background for studying European integration.

  • An overview of the post-Second World War historical development of European integration is presented in Chapter 1. The chapter should be useful to all students, even those who are familiar with the main historical events, as this chapter stresses the economic and political economy logic behind the events.
  • A concise presentation of the indispensable background information necessary for the study of European integration is presented in Chapter 2. This includes key facts concerning European economies and a brief review of the EU’s legal system and principles. Chapter 2 also presents information on the vital EU institutions and the EU’s legislative processes as well as the main features of the EU budget.
  • Chapter 3 presents an economic framework for thinking about EU institutions. The first part explains how the ‘theory of fiscal federalism’ can be used to consider the appropriateness of the allocation of powers between EU institutions and EU Member States. The second part explains how economic reasoning – game theory in particular – can be used to analyse EU decision-making procedures for their decision-making efficiency as well as their implications for the distribution of power among EU members. While these are not classic topics in the study of European integration, they are essential to understanding the current challenges facing the EU, such as the 2004 enlargement and the debates around the Lisbon Treaty.
  • Part II presents the microeconomic aspects of European integration.

  • An introduction to the fundamental methods of trade policy analysis is presented in Chapter 4. The chapter introduces basic supply and demand analysis in an open economy, the key economic welfare concepts of consumer and producer surplus, and uses these to study the simple economics of tariff protection.
  • An in-depth analysis of European preferential trade liberalization is given in Chapter 5. The focus is on how the formation of a customs union or free trade area affects people, companies and governments inside and outside the integrating nations.
  • A thorough study of how the market-expanding aspects of European integration affects the efficiency of European firms is presented in Chapter 6. The main line of reasoning explains how integration in the presence of scale economies and imperfect competition can produce fewer, bigger and more efficient firms facing more effective competition from each other.
  • Chapter 7 gives a detailed study of the growth effects of European integration. The emphasis is on the economic logic linking European integration to medium-run and long-run growth effects. Neoclassical and endogenous growth theory are covered, as are the basic facts and empirical evidence.
  • Chapter 8 deals with the labour markets. It recalls the basics of labour economics in order to explain unemployment and develop the notion that social requirements may have seriously negative effects in terms of jobs, wages and growth. The chapter uses these insights to study the effects of integration. It deals with many controversial issues such as social dumping and migration, trying hard to stay above the fray by presenting economic analysis as one logic, not the only one.
  • Part III continues the approach of Part II by providing the basic principles behind macroeconomic and monetary integration.

  • The principles needed for the macroeconomic analysis are preseneted in Chapter 9. This chapter provides a bird’s eye view of macroeconomics, with an emphasis on the role of capital movements and their implications for the role of monetary policy under different exchange rate regime. The chapter includes a review of the Mundell-Fleming model designed for readers who need to tool up.
  • The choice of the exchange regime is the main objective of Chapter 10. It explains how to assess the desirability of each of the main possible arrangements. It includes a presentation of the two-corner strategy, which explains both why some countries have adopted the euro while others have chosen to retain their own currencies. The usefulness of this analysis is demonstrated through a brief overview of Europe’s monetary history, from ancient times when Europe was a de facto monetary union under the gold standard all the way to the adoption of a single currency.
  • Chapter 11 presents the optimum currency area theory that helps to understand the main costs and benefits from sharing a common currency. The theory does not provide a black-and-white answer; rather it develops a set of economic, political and institutional criteria to evaluate the costs and the benefits of forming a monetary union. In addition, the costs and benefits may be endogenous. Europe fulfils some criteria but not others, which explains the unending debates on the merits of the European monetary union.
  • Part IV presents the main microeconomic policies of the EU.

  • Chapter 9 looks at the Common Agricultural Policy (CAP), presenting the economics and facts that are essential for understanding its effects. The chapter takes particular care to examine the economic forces behind recent CAP reform in the light of international trade negotiations (the Doha Round) and the 2004 enlargement.
  • Chapter 10 presents the economics that link European integration to the location of economic activities. This includes a presentation of the main facts on how the location of economic activity has shifted both within nations and between nations. To organise thinking about these facts – and to understand how EU regional policy might affect it the chapter presents the locations effects of integration in the light of neoclassical theories (Heckscher–Ohlin) as well as the so-called new economic geography. The chapter also presents the main features of the EU’s regional policy and considers the implications of the 2004 enlargement.
  • Chapter 11 covers the basic elements of the EU’s competition policy and state aid policy (EU jargon for subsidies). Instead of just describing the policies, the chapter motivates and explains them by introducing the basic economic logic of anticompetitive practices. It also presents several cases that illustrate the difficulties of applying simple economics to the complex world of international business.
  • Chapter 12 addresses EU trade policy, i.e. its commercial polices with the rest of the world. While trade policy is not as central to the EU as, say, the CAP and cohesion policies are, it is important. The EU is the world’s biggest trader, and trade policy is probably the only EU ‘foreign policy’ that is consistently effective. The chapter covers EU trade policy by presenting the basic facts on EU trade, covering the EU’s institutional arrangements as concerns trade policy, and finally summarising the EU’s policies towards its various trade partners.
  • Part V is the counterpart to Part IV as it presents the main macroeconomic policies of the EU.

  • Chapter 16 deals with the European Monetary System, its now defunct first version and the new version, which is a required step towards monetary union membership. It shows that the successes of the EMS have provided a powerful incentive to go further and create a single currency, while its shortcomings have made the adoption of the euro look like the least bad of all options. Its current role is also presented
  • The main features of the European monetary union are laid out in Chapter 17.This includes a description and an analysis of the institutions created by the Maastricht Treaty. It explains the importance attached to price stability and the measures adopted to achieve this objective. The chapter also provides a review of the first decade of the euro, assessing the performance of the ECB and current debates.
  • Fiscal policy is the last national macroeconomic instrument remaining once national monetary policy has been lost. Chapter 18 looks at the Stability and Growth Pact, designed to deliver enough budgetary discipline not to endanger the overriding price stability objective. As we suggested in the first edition of this book, the Pact had serious shortcomings, and they have forced a revision. The revision and the events that made it necessary are presented, along with remaining doubts about the chosen solution. We emphasise the economic and political difficulties inherent to preserving the last national macroeconomic instrument while ensuring fiscal discipline.
  • The last chapter deals with the financial markets. The financial services industry is being transformed by the Single European Act 1986 and by the adoption of a single currency. Chapter 19 starts with a review of what makes this industry special and then introduces the microeconomics of capital integration. This makes it possible to interpret the changes that have taken place and those that have not yet materialised. Financial markets are also important for monetary policy effectiveness, raising delicate questions: Is the single monetary policy symmetrically affecting member countries? How are financial institutions regulated and supervised? The chapter also examines whether the euro is becoming a worldwide currency, alongside the US dollar.
  • How to use this book

    The book is suitable for a one-semester course that aims at covering both the microeconomics and the macroeconomics of European integration. If the course is long enough, the book can be used sequentially; this is how we teach, and it works well.

    Shorter courses may focus on the trade and competition aspects; they can use only Parts I, II and IV. Conversely, a course dealing only with the macroeconomic aspects can use Parts III and V, and finish with labour market issues as covered in Chapter 8 (which does not really require the previous microeconomic material).

    Eclectic courses that focus on theory and cover trade, competition and macroeconomics, can use only Chapters 1 to 11, or just 4 to 11.

    Eclectic courses oriented towards policy issues can use, with some additional lecturing if the students are not familiar with basic theory, Chapters 1, 2, and 12 to 19. In general, all chapters are self-contained but, inevitably, they often refer to results and facts presented elsewhere.

    Each chapter includes self-assessment questions designed to help the students check how well they master the material, and essay questions which can be given as assignments. We also provide additional readings; most of them are easily accessible to undergraduate students though, occasionally, when we did not find adequate references, we point to more advanced material. Students may find some of these readings rewarding.

    The third edition continues with our tradition of providing many internet links that should allow students and lecturers alike to get the latest information on the EU’s many fast-developing areas. We have observed that the internet is an excellent way to stimulate students’ interest by bringing classroom teaching to real issues they see every day in the media. While lecturers have long used reference to print and broadcast media for the same purpose, the links we provide go well beyond journalist treatments in a way that allows students to realise the usefulness of the basics they have learned from the text.


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