Europe’s challenging economic integration: Insights from a new index

Ettore Dorrucci, Demosthenes Ioannou, Francesco Mongelli, Alessio Terzi 15 April 2015

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The process of European integration has brought about the largest and most open common market in the world, the euro, and the banking union. As further steps are being discussed – especially following the Four Presidents’ Report of December 2012 (Van Rompuy 2012) – it is useful to take a long view.

Our recent work provides insight into this historical view by updating the European index of regional institutional integration (Dorrucci et al. 2015). The index maps developments in European integration from 1958 to early 2015 on the basis of a new monthly dataset. It shows where progress was made, but also flags where efforts are still indispensable.

Europe’s economic integration narrative

From the Treaties of Rome (January 1958) to the Maastricht Treaty (November 1993), Europe moved gradually but unambiguously towards closer economic integration – i.e. an ‘internal market’. Inherent to the pursuit of the internal market was a need for intra-area exchange rate stability. When the externally arranged Bretton Woods exchange rate system broke down, it was replaced by European arrangements (the ‘snake’, and then the EMS). Given the difficulties, the idea of a single currency, first explored by the Werner Report of 1970, was abandoned.

Yet, in the late 1980s and early 1990s, when regional integration made important strides, this idea re-emerged. The single monetary policy was considered as a logical complement to the need for stable exchange rates and the new regime of free capital movement that were implied by the internal market. The favourable political momentum came with Germany’s Wiedervereinigung.

In the eyes of many, from an economic perspective the launch of the euro and the Eurozone was just – very reductively – a sort of ‘cherry on the internal market pie’. Also for that reason, diverse recommendations on more compelling economic and fiscal union, contained in the Delors Report of 1989, were watered down in the less ambitious compromise signed in Maastricht in 1992.

In the same vein, the 1997 version of the Stability and Growth Pact proved too weak and was even watered down in 2003-05. On the whole, a collective failure occurred in the years that preceded the burst of the Eurozone crisis in 2010. It had not been sufficiently understood that the euro implied a major discontinuity in the process of European economic integration; the final goals of European integration had, implicitly but compellingly, changed, and had become much more ambitious than completing the internal market with a single currency and monetary policy.

While this fundamental misunderstanding may be interpreted as one of the many factors at the roots of the Eurozone crisis, the crisis in turn acted as a de facto catalyst for the dramatic acceleration we have witnessed in the pace of reform of European governance. A milestone was reached with the Four Presidents’ Report of December 2012 (Rompuy et al. 2012), which for the first time acknowledged that, alongside monetary union, Eurozone governance was requiring the pursuit of four major, complementary goals: a more effective economic union, fiscal union, financial union, as well as a commensurate political union. Different views, however, persist about the ingredients of these unions and their depth.         

Measuring European integration

The narrative sketched above is captured in Figure 1, which presents a quantitative index of the path of EMU-relevant institutional integration in Europe since the late 1950s (see Dorrucci et al. 2015, including for the methodology).1 Our novel monthly dataset is articulated along two overarching periods of institutional integration:   

  • The ‘Common Market Era’, from 1958 until 1993; and 
  • The ‘Union Era’ thereafter.  

A maximum score of 50 is assigned to each of these periods, with the index starting at 0 on 1 January 1958 (when the Treaty of Rome entered into force) and then making progress up to the current cumulated value of slightly above 76 as of 1 January 2015. The gap between 100 – i.e., the maximum total score that would be assigned in the index if all objectives of the Common Market and Union Eras were fully accomplished – and the current total score gives an indication of the distance still to be covered until a ‘new perceived steady state’ is achieved in the process of integration.2

Figure 1. European Index of Regional Institutional Integration (THE INDEX) Concerning the Common Market era, the index draws on the traditional classification of regional economic integration by recognising five ‘stages’ of integration (Balassa 1961), as shown in Figure 1:

  • A free trade area and customs union (stages 1 and 2);
  • The gradual build-up of the European internal market (stage 3);
  • Some degree of coordination of, for instance, exchange rate policies (stage 4); and
  • A number of institutions, laws, and decision-making processes which can be defined – though to different degrees – as supranational in nature (stage 5).

Given the final goal of a fully-fledged common market, this process was not too far from being completed in the early 1990s, though additional work needed (and still needs) to be done to complete the internal market.

Figure 1 also illustrates the major discontinuity in the integration process that was implied by the start of stage two of EMU in 1994. It was only at the end of 2012, with the Four Presidents’ Report, that the need to complement the monetary union with the other four unions was clearly articulated. At the same time, when the Maastricht Treaty was signed, very few would have anticipated the crisis-driven institutional quantum leap occurred in the period 2010-14, which accounts for 12 points in our index or 16% of the overall progress made since 1958.

Figure 2 zooms on two specific dates in the Union Era, namely May 2010 (start of the Greek programme) and January 2015. It illustrates the institutional progress made during the Eurozone crisis under each component of the Union Era, expressed as a percentage of the final objectives set both in the existing EU legislative framework and the Four Presidents’ Report. Clearly, the strongest improvements have been witnessed under the headings of the fiscal and banking unions, whereas more needs to be done as regards the economic union.

Figure 2. Union Era: Progress made under the economic, fiscal, monetary, and financial union, and the related democratic legitimacy and accountability (in percentage of the maximum achievable under the current EU legislation and the Four Presidents’ Report)

Figure 3 completes the picture by showing where all components of the index stand as of 1 January 2015, including in red some elements that have already been decided but not yet implemented. Some interesting conclusions can be drawn:

  • First, there is still progress to be made with the internal market (see ‘IM’ bar) as regards both the single market for services and labour mobility.

From an OCA theory perspective, the importance of this cannot be underestimated also from the perspective of the single currency.

  • Second, under the Union Era, while the monetary union as such is virtually accomplished (‘MU’ bar), a lot of progress has still to be made in the other dimensions.3

Nonetheless, the recent banking union has marked a gigantic step, and the degree of accomplishment of the financial market union (‘FMU’ bar) is expected to jump from the current 55% to 72% once all measures already scheduled will be implemented (e.g. bail-in procedures under the BRRD, setting up of the Single Resolution Fund, etc.).

  • Third, apart from an initial agreement on enhanced cooperation in financial sector taxation (FTT), there are no additional steps agreed going forward as regards the fiscal union.

The Four Presidents’ Report, however, mentions – or implies in our reading – further potential objectives, such as the development of a Eurozone fiscal capacity; the institution of a EU finance ministry that would take over, for example, fiscal surveillance so as to internalise the negative externalities of this process; and, if a number of preconditions are fulfilled, even the common issuance of debt (bar ‘FIU’). It has to be seen whether such goals will be taken forward and how.

  • Fourth, the economic union clearly lags behind, especially in the area of structural policies (e.g. via national reform contracts, greater traction of country-specific recommendations, and an EU finance ministry that monitors competitiveness more effectively, see Wolff and Sapir 2015).

Moreover, a more cogent economic surveillance than is currently the case is badly needed, while the debate is open on a Eurozone-wide macroeconomic stabilisation mechanism. None of such steps is likely to be implemented for the time being (bar ‘EUN’).

Fifth, political union is currently only seen as the complement needed to be able to achieve the accountability and legitimacy of the economic governance developed in the other unions, rather than as a process on its own.

This explains the relatively low score we assign in our index to the item ‘democratic legitimacy and accountability’ (bar ‘DL&A’). Even along the existing narrow definition, however, significant progress still needs to be made to match the future advances in the other three unions with adequate democratic accountability. 

Figure 3. Degree of completion of the various steps of European regional institutional integration in the economic sphere

Conclusions

The process of economic integration in Europe has been always incremental in nature, and often ‘forged in crises’ (Monnet 1978). In this column we have shown that this can be seen as the ‘natural condition’ of European integration as long as the final goals of integration are well identified and understood from the outset of the process.

It took 35 years to establish the internal market, and yet in this period there was no doubt about the path of economic integration to be followed. Conversely, the issue with the Union Era lies in the uncertainty and ambiguity of some of its final goals. This is in turn a by-product of the very high degree of national sovereignty pooling implied at this stage, which calls for properly addressing the ultimate question of democracy in Europe. In this context, the traditional incremental approach becomes much more precarious and the outcome of crises much less predictable. Not to deny that tremendous progress has been made since 2010. Hopefully, 2015 will mark another milestone towards better European governance under the four unions.

Disclaimer: The views expressed in this column are those of the authors and do not necessarily reflect those of the European Central Bank.

References

Balassa, B (1961), The Theory of Economic Integration, Richard Irwin, Homewood.

Delors, J et al. (1989): “Report on Monetary and Economic Union in the European Community”, Committee for the Study of Economic and Monetary Union, 17 April.

Dorrucci, E, D Ioannou, F P Mongelli, and A Terzi (2015), “The Four Unions “PIE” on the Monetary Union “CHERRY”: A New Index of European Institutional Integration”, ECB Occasional Paper No. 160 (February).

Juncker, J-C et al. (2015), “Preparing for the Next Steps on Better Economic Governance of the Eurozone, by the Four Presidents of the European Council, European Commission, Eurogroup and the ECB" (12 February).

Mongelli, F P (2013), “The mutating Eurozone crisis – Is the balance between ‘sceptics’ and ‘advocates’ shifting?”, ECB Occasional Paper Series, No 144.

Monnet, J (1978), Memoirs, London.

Van Rompuy, H (2012), “Towards a Genuine Economic and Monetary Union”, in close cooperation with the Four Presidents of the European Council, European Commission, Eurogroup and the ECB (December).

Wolff and Sapir (2015), “Eurozone governance: What to reform and how to do it”, Bruegel Policy Brief, (27 February).

Footnotes

1 It should be recalled that the methodology for constructing the EURII index can be considered as being objective in nature as regards the measurement of the various steps leading to the completion of the free trade area and customs union, since the removal of tariffs and quotas and the introduction of common external tariffs are easily quantifiable. On the other hand, our methodology, while being as unbiased as possible, presents some unavoidable subjective elements with regard to the other components of the index and their aggregation. Nonetheless, as our database is public, one can change the calibration of whichever steps and components of the index one disagrees with. We suspect our main conclusions would remain broadly unchanged.

2 Of course, in the current version of the index the objectives identified for the Union Era are still based on the December 2012 version of the Four Presidents’ Report.

3 This will be achieved in June 2015 with the start of the unified payment system for securities (T2S).

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Topics:  EU institutions EU policies

Tags:  European integration, common markets, European Union, internal market

Head of Convergence and Competitiveness Division in the Directorate General Economics, ECB

Principal Economist in DG-I, ECB

Senior Adviser in the Directorate General Research, ECB; Honorary Professor, Johann Wolfgang Goethe University of Frankfurt

Affiliate Fellow, Bruegel

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