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News Release

Outlook for the Integration of the EU
- The elimination of internal differentials by the direct investment route -

October 07, 2005

Overview

In recent years, steady progress has been made towards the integration of the EU (European Union), with the introduction of a common currency, the Euro, in January 1999 and the accession of ten Central and Eastern European countries to the Union in May 2004. However, since the beginning of 2005, following the rejection of the EU Constitution by France and the Netherlands, skepticism regarding the future of the EU has been growing. This article examines the outlook for the movement to unify Europe.

European unification has three stages: (i) market unification (completed in 1993), (ii) economic and monetary unification (competed in 1999), and political unification (now under consideration). The eastward expansion in May 2004 means that the EU now rivals or even outstrips the United States as an economic power.
With the United States as a latent competitor in mind, the basic aims of European integration itself were (i) to unify markets with a view to enhancing the efficiency of economic activity within the EU and achieving economies of scale and (ii) to complement market unification with economic and monetary unification so as to maximize its benefits.

At the planning stage, the EU itself envisaged three major concrete benefits of integration: (i) greater efficiency at a microeconomic level, (ii) greater stability at a macroeconomic level and (iii) greater fairness between countries and regions within the EU. To date, integration has certainly achieved (i) greater efficiency at a microeconomic level in terms of facilitating business activity within the EU and (ii) greater stability, in that macroeconomic indicators within the EU are converging.

In recent years, however, integration has begun to have a negative impact in the form of a polarization of the pace of economic growth among member countries. This is due to two factors: (i) because the framework of the EU itself was intended to integrate the economies of countries between which economic gaps had existed from the start, as market unification has led to the integration of economic activity in the member countries, pressure for the elimination of differentials in level of income, etc. has naturally come into play, and this has had a negative impact on countries with a high income and a positive impact on countries with a low income; (ii) in the Euro zone, the management of monetary policy has been brought under the control of the European Central Bank and, owing to the existence of a mechanism designed to ensure fiscal discipline in the EU as a whole (the Growth and Stability Pact), member countries operate economic policy in accordance with their own national economic trends, with the result that there is little scope for measures to relieve the pressure for the elimination of differentials within the EU.

Even since the completion of market unification in 1993, there has been little movement of labor between member countries. For this reason, the pressure for the elimination of economic differentials that is the principal cause of the polarization of the pace of economic growth has acted largely via the "direct investment route", whereby manufacturing companies in countries where industrial competitiveness is high and the unit cost of labor is high (e.g. Germany, the Netherlands) have transferred production bases to countries where the cost of labor is low (Ireland, Spain, the Middle East). The introduction of the Euro in 1999 and the expansion of 2004 have increased this pressure for the elimination of differentials. As a result, the economic growth of countries receiving direct investment has accelerated, largely on the strength of increased exports. Meanwhile, Germany and other developed nations have seen capital investment diverted to neighboring countries. This has brought a fall in employment, downward pressure on incomes and, because the ratio of their output accounted for by the processing and export of goods imported from neighboring countries in a semi-manufactured state has risen, the unit added value of their exports has fallen. As a result, the downward trend of economic growth rates has become clearer.

The mechanism for the elimination of economic differentials within the EU by the direct investment route appears to have weakened slightly in recent months. However, given that there are still considerable differentials between member countries, it is likely that the pressure for their elimination will persist. By what process and on what scale this will come about depends on how the integration of the markets of new member countries is pursued and how the reform of the labor markets is pursued among the developed nations and among the newly acceded late-developing countries of the EU.

Looking to the future, after the "euphoria" of recent years, it is highly likely that the EU will enter a phase in which the pace of integration will slow down. Specifically, the most likely scenario is that, while the framework of economic and monetary unification, which is already in place, is maintained, moves towards political unification will be held back, the market integration of new member countries (including the full liberalization of the movement of labor) will be put off, and the number of countries joining Euro will also be small.

For more information on the content of this report, please contact: Sayuri Kawamura the Japan Research Institute, Limited.

Tel: 03-3288-4148
E-mail:kawamura.sayuri@jri.co.jp

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