INSTITUTIONS AND DECISION MAKING

© Baldwin&Wyplosz 2006 The Economics of European Integration, 2nd Edition 1

INSTITUTIONS AND DECISION MAKING


Main Elements• Free trade in goods.

– Eliminate tariffs, quotas and all other barriers that act like tariffs or quotas.

• Common trade policy with the rest of the world.– Formation of a Customs Union necessary to avoid controls inside

EU (Rules of Origin); also forces a degree of supranationality.• Ensuring undistorted competition (to avoid other policies

offsetting trade barrier removal). Main:– State aids prohibited,– Anti-competitive behaviour,– Approximation of laws (Euro-jargon for harmonisation) necessary

to ensure free movement of goods,– Taxes (weak restrictions aimed at preventing subsidies via lower

tax rates for some firms); no explicit harmonisation or coordination.


Main elements (cont’d)• Unrestricted trade in services.

– ToR established principle of freedom of movement of services, but implementation has been hard.

• barriers are part of domestic economic regulations that are not explicitly coordinated by ToR (e.g. banking regulation is necessary, not subject to EU decision making and can hinder cross-border banking).

• Single European Act made some progress, new EU Services Directive (maybe adopted in 2006) should do more.

• Labour and capital market integration.– Free movement of workers in ToR.

– Free movement of capital was in principle but many loopholes.• 1950s economists were sceptical about capital mobility after inter-war

problems;

• most EU nations retained important capital controls until the Single European Act.


Main elements (cont’d)• Exchange rate and macroeconomic co-ordination

– ToR includes mechanisms for coordinations; most macro and exchange rate coordination remained informal or outside EU institutional structure until Maastricht Treaty.

• See Chapters 13 and 15.

• Common agriculture policy (CAP).– Commitment in ToR but no details; CAP set up in 1962.– Used to be a much more important sector than it is today

• In France about 1/3 of population was involved in agriculture in 1950s; today less than 5%.

• See Chapter 9.


Omitted elements• Social policies.

– Argument was that ‘general policies’ (i.e. not sector specific) did not distort competition and so did not need to be harmonised (contrast with competition policy).

• Gains to harmonisation small.

• France forced exception for one policy into ToR: equal pay for men and women (was aimed at avoiding uneven competition in clothing section in 1950s).

– Basic idea was that national wage and exchange rates would adjust to offset any unfair advantage.

• If lower social standards meant lower production costs, long-run result would be higher wages that offset the advantage.

– Political costs of harmonisation very high.• Social policies touch workers lives and EEC6 had very different

approaches.


Omitted elements• Single currency.

– EU founders believed fixed exchange rates were important to economic integration and political support for free trade.

• e.g. inter-war experience of link between ER volatility and protectionist pressures.

– But, 1950s exchange rates fixed worldwide by well-function IMF system “Bretton Woods” so no need for strong measures in ToR.

– First plan for single currency came in 1970 (“Werner Report”) as pressure on Bretton Woods began to grow.


Maastricht: 2nd ‘foundation treaty’• The Maastricht Treaty (known as Treaty

Establishing the European Union) was:– Massive step up in economic integration

• Monetary union

– Massive institutional change that delimited extent of future EU integration more clearly (the pillars).


Organisational structure: 3 pillars & a roof• Member State concern over

“creeping competencies” led to introduction of pillars in Maastricht Treaty and creation of EU.– EU’s tendency to expand

integration to new areas.– ToR goal “ever closer” union

+ Commission & Court interaction produced progressively deeper & wider integration.

• EC (old EEC) is now 1st pillar.

• The EU’s 3-Pillar Structure– 1st: Economics– 2nd: Security & Foreign– 3rd: Justice

• EU is ‘roof’ over the three pillars.

European Union

ECThe European Community

(Supranational decision making)

Justice and Home Affairs

(no supranational decision making)

JHACommon Foreign

and Security Policy

(no supranational decision making)

CFSP

• Pillar structure limits the authority of EU Court and Commission to 1st pillar issues.

• Makes it clear that Member States in charge of 2nd and 3rd pillar issues.


Quantifying European economic integration

0

10

20

30

40

50

60

70

80

90

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

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1980

1982

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1990

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1994

1996

1998

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Inte

grat

ion

ind

ex

Customs Union phased in 1958-68

CAP, 1962 Monetary

integration failures

EMS, 1979

Single Market Programme phased in, 1986-1992

EMU phased in, 1993-2001

DFFM index

BN index


EU Law• One of the most unusual features of the EU is its

legal system.– No other regional integration arrangement in the world is

even close to extensiveness of supra-national law.– Formally ‘EC Law’ is part that has strong supranational

elements, while ‘EU Law’ is more intergovenmental.• EC Law applies only to first pillar (this would change if the

Constitutional Treaty is passed since it eliminates the pillars).

• Understanding basics of EU law is critical to understanding past & future developments of European economic integration (applies mostly to economic issues).


Law: “Sources” of EC Law• The EU Court created by the Treaty of Rome

– Court then established the Community’s legal system. – two landmark cases in 1963 and 1964.

• EC law was established on the basis of:– The EU institutions ensuring that actions by the EC take

account of all members’ interests, i.e. the Community’s interest;

– The transfer of national power to the Community.• Source: Borchardt (1999 p.24)

• Constitutional Treaty (CT) would replace this as the source of EU law.– CT repeals & replaces all other EU Treaties.


Law: Key principles of EC Law• 1. Autonomy

– system is independent of members’ legal orders.

• 2. Direct Applicability– has the force of law in member states so that Community

law can be fully and uniformly applicable throughout the EU.

• 3. Primacy of Community law– Community law has the final say; e.g. highest French court

can be overruled on a matters pertaining to intra-EC imports. • Necessary so Community law cannot be altered by national,

regional or local laws in any member state. – Source: Borchardt (1999)


Law: Types of EU legislation

• Primary legislation.– Treaties.

• Secondary legislation. – Collection of decisions made by EU institutions

“acquis communitaire.”

• 5 types of secondary law– 1. regulation

• applies to all member states, companies, authorities and citizens. Regulations apply as they are written, i.e., they are not transposed into other laws or provisions. They apply immediately upon coming into force.


Law: Types of EU legislation – 2. directive

• may apply to any number of member states, but they only set out the result to be achieved.

• member states what needs to be done to comply with the conditions set out in the directive (e.g. new legislation, or change in regulatory practice).

– 3. decision • is a legislative act that applies to a specific member state,

company or citizen.

– 4. & 5. Recommendations and opinions • These are not legally binding, but can influence behaviour of,

for example, the European Commission, national regulators, etc.

• Would be simplified if CT is ratified.


Some important facts: Population• ‘Big’ nations (>35 million); Larger

than largest city in the world.– Germany, the UK, France, Italy, Spain

and Poland.

• ‘Medium’ nations (8 to 11 million; like mega-city, e.g. Paris metro region).– Greece, Portugal, Belgium, the Czech

Republic, Hungary, Sweden and Austria, Bulgaria.

• ‘Small’ nations (like big city, e.g. Barcelona, or Lyons. – Denmark, Slovakia, Finland, Ireland,

Lithuania, Latvia, Slovenia, and Estonia.

• ‘Tiny’ nations (like small city, e.g. Genoa).– Cyprus, Luxembourg and Malta.

• Netherlands & Romania fall in between big and medium.

82.570.2

59.959.7

57.942.3

38.221.8

16.311.010.510.410.210.1

9.08.17.8

5.45.45.2

4.03.4

2.32.01.40.70.50.4

0.0 20.0 40.0 60.0 80.0 100.0

GermanyTurkeyFranceBritain

ItalySpain

PolandRomania

NetherlandsGreece

PortugalBelgium

Czech Rep.HungarySwedenAustria

BulgariaDenmarkSlovakiaFinlandIreland

LithuaniaLatvia

SloveniaEstoniaCyprus

LuxembourgMalta

Population 2004 (millions)


Facts: income per capita • 11 high income (above EU25

average) over €21,400 – Denmark, Ireland, Austria,

Netherlands, Belgium, Finland, Italy, Germany, France, UK, and Sweden.

• 10 medium income category – from €10,000 to €21,000– Spain, Greece and Portugal,

Cyprus, Slovenia, Malta, the Czech Republic, Hungary, Slovakia, and Estonia .

• 6 low income nations, less than €10,000– Lithuania, Poland, Latvia,

Romania, Bulgaria, and Turkey • Luxembourg is in the super-

high income category by itself. – per capita income is almost twice

that of France.

45,90028,300

26,20026,10025,80025,30025,200

24,60024,300

23,70023,10022,800

20,90017,40017,300

16,40016,00015,800

14,70012,900

11,10010,400

9,8009,800

8,8006,7626,3776,185

€ 0 €5,000

€10,000

€15,000

€20,000

€25,000

€30,000

€35,000

€40,000

€45,000

€50,000

LuxembourgIreland

DenmarkAustria

NetherlandsBritain

BelgiumSwedenFinlandFrance

GermanyItaly

SpainCyprusGreece

SloveniaPortugal

MaltaCzech Rep.

HungarySlovakia

EstoniaLithuania

PolandLatvia

RomaniaBulgariaTurkey

Income per inhabitant 2003 (PPS)

PPS is Commission’s adjustment for cost of living (Purchasing Power Standard


Facts: Size of economies • Economic size distribution is VERY

uneven.• 6 nations (Germany, the UK, France,

Italy, Spain and the Netherlands) account for more than 80% of EU25’s economy.

• Other nations are small, tiny or miniscule,

• ‘Small’ is an economy that accounts for between 1% and 3% of the EU25’s output.– Sweden, Belgium, Austria, Denmark,

Poland, Finland, Greece, Portugal and Ireland.

• ‘Tiny’ is one that accounts for less than 1% of the total.– Czech Republic, Hungary, Slovak

Republic, Luxembourg, Slovenia, Lithuania, and Cyprus.

• Miniscule as one that accounts for less than one-tenth of one percent. – Latvia, Estonia and Malta.

GDP, current prices, 2004

I

F

UK

IrePGr

L

EstMal

E

D

FinDKSNL B A

Lat

PolCz

Hu

SRSl

LithCyp


The budget: Expenditure

Expenditure is on 3 things:- Agriculture (about half).- Cohesion (about one third)- All else (rest)


0.0

0.2

0.4

0.6

0.8

1.0

1958

1961

1964

1967

1970

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1976

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1982

1985

1988

1991

1994

1997

2000

2003

2006

% o

f Bud

get

Administration

External

Other Internal

Cohesion

CAP

Evolution of spending priorities


Evolution of spending, level

Total Spending, Million euros, 1958-2006

0

20,000

40,000

60,000

80,000

100,000

120,000


0 500 1,000 1,500 2,000 2,500

UK

Germany

Sweden

Italy

Austria

NL

EU average

Finland

France

Spain

Denmark

Portugal

Belgium

Greece

Ireland

Luxembourg

euro per person

Operational Expenditure/Pop

Expenditure/Pop

Evolution of spending, level

0 3,000 6,000 9,000 12,000 15,000

Luxembourg

Finland

Sweden

Austria

Denmark

NL

Ireland

Portugal

Belgium

Greece

UK

Italy

Germany

Spain

France

Million euros

CAP

Cohesion

Oth. Internal

Administration


Funding of EU Budget• EU’s budget must balance every year• Financing sources: four main types

– Tariff revenue – ‘Agricultural levies’ (tariffs on agricultural goods)– ‘VAT resource’.

• Like a 1% value added tax (reality is complex).

– GNP based. • tax paid by members based on their GNP.

• Miscellaneous– relatively unimportant since 1977– taxes paid by eurocrats, fines and earlier surpluses– Pre-1970s direct member contributions


Evolution of Funding sources

0%

20%

40%

60%

80%

100%

197119721973197419751976

19771978197919801981

19821983198419851986198719881989199019911992199319941995199619971998199920002001

Shar

e of

tota

l rev

enue

GNP

VAT

Miscellaneous

Customs Duties

Agricultural Duties

Source: “The Community Budget: The facts in figures” European Commission, 2000. Downloadable from http://eurpoa.eu.int/budget/


Contribution vs GDP, 1999, 2000• % of GDP per

member is approximately 1% regardless of per-capita income

• EU contributions are not ‘progressive’

• e.g. richest nation, (L) pays less of its GDP than the poorest nation (P)

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

Portugal

Greece

Spain

Italy

France

Belgium

UK

Finland

EU

15 Median

Netherlands

Ireland

Germ

any

Austria

Sweden

Denm

ark

Luxem

bourg

€0

€5,000

€10,000

€15,000

€20,000

€25,000

€30,000

€35,000

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€45,000

€50,000Contribution/GDP, 1999

Contribution/GDP, 2000

GDP per capita, 1999 (right scale)


Net Contribution by Member

-€8,000 -€6,000 -€4,000 -€2,000 €0 €2,000 €4,000 €6,000 €8,000

SpainGreece

PortugalBelgium

IrelandLuxembourg

FranceDenmark

EU15 MedianFinland

ItalyAustriaSweden

NetherlandsUK

Germany

Net Financial Contribution, 2000

Net Financial Contribution, 1999


Task allocation and subsidiarity • Key question: “Which level of government is

responsible for each task?”– Setting foreign policy

– Speed limits

– School curriculum

– Trade policy, etc

• Typical levels:– local

– regional

– national

– EU

• Task allocation = ‘competencies’ in EU jargon


Subsidiarity principle• Before looking at the theory, what is the practice in

EU?• Task allocation in EU guided by subsidiarity

principle (Maastricht Treaty)– Decisions should be made as close to the people as

possible, – EU should not take action unless doing so is more

effective than action taken at national, regional or local level.

• Background: “creeping compentencies”– Range of task where EU policy matters was expanding. – Some Member States wanted to discipline this spead.


3 Pillars and task allocation

• 3 Pillar structure delimits range of:– Community competencies (tasks allocated to EU).– Shared competencies (areas were task are split

between EU and member states).– National competencies.

• 1st pillar is EU competency.

• 2nd and 3rd are generally national competencies– details complex, but basically members pursue

cooperation but do not transfer sovereignty to EU.


Theory: Fiscal federalism• What is optimal allocation of tasks?

• Basic theoretical approach is called Fiscal Federalism.– Name comes from the study a taxation, especially which

taxes should be set at the national vs sub-national level.


Fiscal federalism: The basic trade-offs • What is optimal allocation of tasks

– NB: there is no clear answer from theory, just of list of trade-offs to be considered.

• Diversity and local informational advantages• Diversity of preference and local conditions argues for setting policy at low

level (i.e. close to people).

• Scale economies• Tends to favour centralisation and one-size-fits-all to lower costs.

• Spillovers• Negative and positive spillovers argue for centralisation.

– Local governments tend to underappreciated the impact (positive or negative) on other jurisdictions. (Passing Parade parable).

• Democracy as a control mechanism• Favours decentralisation so voters have finer choices.

• Jurisdictional competition• Favours decentralisation to allow voters a choice.


Closer look at the trade-offs


Diversity and local information• One-size-fits-all

policies tend to be inefficient since too much for some and too little for others.

• central government could set different local policies but Local Government likely to have an information advantage. Qd2Qd1 Qc,1&2

D1

D2

Davg

MC per person

MVc,2

MVc,2

A

B

Quantity

euros


Scale• By producing public

good at higher scale, or applying to more people may lower average cost.

• This ends to favour centralisation.– Hard to think of

examples of this in the EU.

Qd1 Qc,1&2

D1

Davg

MC p.p. (decentralised)

C

D

MC p.p. (centralised)

Quantity

euros


Spillovers• Example of a positive

spillovers.• If decentralised, each region

chooses level of public good that is too low.– e.g. Qd2 for region 2.

• Two-region gain from centralisation is area A.

• Similar conclusion if negative spillovers.– Q too high with

decentralised.

Qd2 Qc,1&2

Combined region 1 & 2 Marginal Benefit Curve

MCd

Quantity

euros

Private and Social Marginal Cost

Region 2’s Marginal Benefit Curve (demand curve)

MCc A


Democracy as a control mechanism• If policy is in hands of local officials and these are

elected, then citizens’ votes have more precise control over what politicians do.

• High level elections are take-it-over-leave-it for many issues since only a handful of choices between ‘promise packages’ (parties/candidates) and many, many issues.– Example of such packages:

• Foreign policy & Economic policy.

• Centre-right’s package vs Centre-left’s package.

• At national level, can’t choose Centre-right’s economics and Centre-left’s foreign policy.


Jurisdictional competition• Voters influence government they live under via:

– ‘voice’ • Voting, lobbying, etc.

– ‘exit’. • Change jurisdictions (e.g. move between cities).

• While exit is not a option for most voters at the national level, it usually is at the sub-national level. And more so for firms.– Since people/firms can move, politicians must pay

closer attention to the wishes of the people. – With centralised policy making, this pressure

evaporates.


Economical view of decision making• Using theory to think about EU institutional

reforms.– e.g., Institutional changes in Constitutional Treaty, Nice

Treaty, etc.

• Take enlargement-related EU institutional reform as example.


EU enlargement challenges

• Since 1994 Eastern enlargement was inevitable & EU institutional reform required.– 3 C’s: CAP, Cohesion & Control. – Here the focus is on Control, i.e. decision making.

• Endpoint: EU leaders accepted the Constitutional Treaty June 2004.

• Look Nice Treaty and Constitutional Treaty.– Nice Treaty is in force now and will remain in force until

new Treaty is ratified.

• Focus on Council of Ministers voting rules.– See Chapter 2; these are the key part of EU decision

making.


Distribution of power among EU members• For EU15, NBI is very similar to share of Council votes, so

the distinction is not so important as in 3 country example.

Power measures in EU15

0%

2%

4%

6%

8%

10%

12%

14%

NBI Vote share

NBI 11.2% 11.2% 11.2% 11.2% 9.2% 5.9% 5.9% 5.9% 5.9% 4.8% 4.8% 3.6% 3.6% 3.6% 2.3%

Vote share 11.5% 11.5% 11.5% 11.5% 9.2% 5.7% 5.7% 5.7% 5.7% 4.6% 4.6% 3.4% 3.4% 3.4% 2.3%

D UK F I E NL Gr B P S A DK SF Ire L


Do power measures matter?

y = 0.9966x + 0.0323R2 = 0.7807

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

0 1 2 3 4

Vote Share/Population Share

Bud

get S

hare

/Pop

ulat

ion

Shar

e

Ireland

Greece

BelgiumPortugal

DenmarkSpain

Finland

AustriaSwedenNL

France

Italy

UK

Germany


Do power measures matter?

0

2

4

6

8

10

12

0 5 10 15 20 25

Vote Share/Population Share

Bud

get S

hare

/Pop

ulat

ion

Shar

e

Luxembourg


Legitimacy in EU decision making• Legitimacy is slippery concept.

– Approach: equal power per citizen is legitimate ‘fair’.

• Fairness & square-ness.– Subtle maths shows that equal power per EU citizen requires Council votes to

be proportional to square root of national populations.

• Intuition for this:– EU is a two-step procedure

• Citizens elect national governments, • These vote in the Council.

– Typical Frenchwoman is less likely to be influential in national election than a Dane.

– So French minister needs more votes in Council to equalise likelihood of any single French voter being influential (power).

– How much more? – Maths of voting says it should be the square root of national population.


Nice Treaty Voting Rules• 3 main changes for Council of Ministers:

• Maintained ‘weighted voting’.– Majority threshold raised.

• Votes re-weighted. – Big & ‘near-big’ members gain a lot of weight.

• Added 2 new majority criteria: – Population (62%) and members (50%).

• ERGO, triple majority system.– Hybrid of ‘Double Majority’ & Standard QMV.


Post Nov 2009 rules• If the Constitution is ratified, then New system after

November 2009: Double Majority.

• Approve requires ‘yes’ votes of a coalition of members that represent at least:– 55% of members,– 65% of EU population.

• Aside: Last minute change introduced a minimum of 15 members to approve, but this is irrelevant.– By 2009, EU will be 27 and 0.55*27=14.85– i.e. 15 members to win anyway.

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INSTITUTIONS AND DECISION MAKING