1European Union EconomyA2 Economics –Study Companion 2012Geoff RileyTutor2uJanuary 2012
2Contents of European Study Companion 20121) Background to the European Union........................................................................................................ 32) The EU Budget: Financing the Activities of the EU .................................................................................. 43) Economic Integration in the EU.............................................................................................................. 54) UK Trade with the rest of Europe ........................................................................................................... 75) The European Union Single Market........................................................................................................ 86) Price Convergence ............................................................................................................................... 127) Value Added Tax and Corporation Tax in Europe.................................................................................. 138) Business Ownership – Privatisation and Nationalisation in the EU........................................................ 149) Measuring the Standard of Living within the EU................................................................................... 1710) Enlargement of the European Union ................................................................................................ 1911) EU Enlargement and the impact on the UK economy........................................................................ 2312) Movement of Labour within the EU.................................................................................................. 2513) Unemployment in the European Union............................................................................................ 2814) Policies addressing Income Inequalities in the EU............................................................................. 3015) EU Competition Policy...................................................................................................................... 3216) EU Farm Policy and Reform.............................................................................................................. 3417) Environmental Issues and Policies in the EU..................................................................................... 3918) European Monetary Union – The Basics of a Single Currency............................................................ 4319) The UK Economy and the Single Currency ........................................................................................ 5320) Exam Style Questions on European Economics................................................................................. 5521) Statistical Snapshot of the European Union...................................................................................... 5622) Glossary of some key terms.............................................................................................................. 57
31) Background to the European UnionThere are twenty seven member nations of theEU – known as EU27. The EU27 includesBelgium (BE), Bulgaria (BG), the Czech Republic(CZ), Denmark (DK), Germany (DE), Estonia (EE),Ireland (IE), Greece (EL), Spain (ES), France (FR),Italy (IT), Cyprus (CY), Latvia (LV), Lithuania (LT),Luxembourg (LU), Hungary (HU), Malta (MT),the Netherlands (NL), Austria (AT), Poland (PL),Portugal (PT), Romania (RO), Slovenia (SI),Slovakia (SK), Finland (FI), Sweden (SE) and theUnited Kingdom (UK).Member nations of the Euro ZoneThe Euro Area consists of Belgium, Germany,Ireland, Greece, Spain, France, Italy, Cyprus,Luxembourg, Malta, the Netherlands, Austria,Portugal, Slovenia, Slovakia and Finland andEstoniaSize of the European Union• The EU accounts for around 30 per cent of the total value of global GDP• In 2010 – there was a total EU population of 503.6 million (compared to USA pop = 315million)• Largest population - Germany 81 million, Smallest – Malta 0.4 million, UK – 62 million• The EU, with 503 million inhabitants, accounts for 7% of the world populationFuture Enlargement• Croatia: Croatia’s application was confirmed in December 2011, she will join in July 2013• Iceland: Iceland applied to join in 2009, seeking the stability of membership when the globalfinancial crisis crushed its banking system. It has made good progress in meeting the entry laws• Former Yugoslav Republic of Macedonia and Turkey are candidate countries• Albania, Bosnia and Herzegovina, Montenegro, and Serbia are potential applicants althoughprogress on Serbia’s application has been delayed until the summer of 2012• Norway and Switzerland are outside of the EU. Norway is a member of the European EconomicArea giving access to EU single market but freedom to pursue her own macroeconomic policiesUK and the EU – the current position• The UK joined the EU in January 1973. It is inside the single market but outside of the singleEuropean currency – it has an opt out negotiated as part of the 1993 Maastricht Treaty• The UK is opposed to further fiscal harmonisation and deeper political union (witness theCameron approach to Treaty change in December 2011!) but it is broadly in favour of furtherenlargement of the single market to bring in more nations from eastern Europe
42) The EU Budget: Financing the Activities of the EURevenue comes from:• Import tariffs (customs duties), agricultural duties and sugar levies (16%)• VAT receipts from member nations (16% of the total income)• Gross National Income (GNI) based contributions from individual states (67% of total income). –Note: The GNI ceiling is currently set at 1.24% of the EU’s GNI. Richer nations always pay more.EU Spending• Cohesion funds – includes regional funding / money for development projects and transitioninto the EU for relatively poorer new member states (sometimes known as “New Europe”)• Natural resources – farming and fishing payments including rural development funding anddirect financial support for farming and fishingThe UK is a net contributor to the EU budget. In 2011 it paid a net contribution of Euro 12 billion.1. To some this is one of the major costs of being part of the EU – anti-EU commentators point out thatthe UK would be better off financially if we left the EU and operated in a similar fashion to Norway2. But on grounds of equity it is fair for richer EU nations to contribute more especially if the cohesion/ structural funds help to sustain a higher rate of growth for the single market as a whole3. And the UK economy benefits from participation in the single market which generates increasedtrade and investment opportunities across many different EU industriesThe main criticism of the EU budget is that for many years, too much money has gone on providing generousbut distorting subsidies to agriculture and not enough to funding research and development and improvedinfrastructure – both of which could help to lift the trend growth rate of the EU as a whole. The total EUbudget is only 1 per cent of EU GDP – the vast majority of tax and government spending is done byindividual nations of the single market. To raise extra revenue the EU Commission has proposed a new EUtax which could take several forms: a tax on air transport or a share of new financial, corporate or energytaxes, or an EU-wide VAT. The UK is likely to oppose this favouring instead reforming EU spending.During 2011 there was increasing attention paid to French and German-led plans to introduce an EU-wideFinancial Transactions Tax (also known as a Tobin Tax). This is designed to “recover the costs of the recentand future financial crises” and correct “undesirable” market behaviour, particularly high-frequency trading.
53) Economic Integration in the EUEurope is a huge economic region - The EU (1090bn euro) was the largest exporter of goods in 2009,followed by China (860bn) and the United States (760bn). The EU (1 200bn) was also the largest importer ofgoods in 2009, followed by the United States (1 150bn) and China (720bn).The development of the EU is a series of stages of economic and political integration between membernations and also an expansion of the size and scope of the single market.Integration can take different forms: there is deeper integration as we go down the following list1. Preferential Trading Area (PTA) e.g. trade agreements between EU and LDCs2. Free Trade Area (FTA) – breaking down trade barriers within group of countries3. Customs Union (CU) – free trade plus a common external tariff (CET)4. Single Market (SM) – built around the four freedoms5. Monetary Union (MU) – a common currency, one policy rate and central bank6. Fiscal Union (FU) – the deepest form of integration, requires some political unionIn a customs union there is a common external tariff plus free trade between members of the union. Thisleads to trade creation and trade diversion effects. In 2010 the average EU import tariff for agricultural goods was 12.8% The average EU import tariff for non-agricultural goods was 4.0%Trade creationTrade creation involves a shift in people’s spending from a higher-cost domestic source to a lower-costpartner-source within the EU, as a result of the abolition of tariffs. For example, UK consumers may switchspending on car insurance away from a higher-priced UK supplier towards a German insurance company thathas decided to operate in the UK market. Trade creation stimulates an increase in intra-EU trade and oughtto lead to a more efficient allocation of scarce resources leading to gains in consumer and producer welfare.Trade diversionTrade diversion happens when there is a shift in domestic consumer spending away from a lower-cost worldsource to a higher cost partner source (e.g. another country within the EU) as a result of the elimination oftariffs on imports from the partner. The common external tariff on many products entering Europe makesimports more expensive leading to higher costs for producers and rising prices for consumers if previouslythey had access to a cheaper supply from a non-EU country. In general, protectionism results in adeadweight loss of welfare. Only short-term measures where there is clear evidence of price dumping whichcauses material injury to an industry can be defended robustly in terms of economic efficiency.The overall effect of a customs union on the economic welfare of citizens within a customs union dependson whether it creates effects that are mainly trade creating or trade diverting. But we must also considerthe impact of these tariffs on the livelihoods of people in countries outside of the EU, for example small-scale exporters in developing countries for whom EU tariffs provide a stiff barrier to free trade.
6Trade CreationTrade DiversionAlways remember the significance of price elasticity of demand and supply in shaping your analysis. Alsoconsider what happens when you drop certain assumptions behind theory.PriceOutput (Q)Domestic DemandDomestic SupplyWorld PriceQdQsPwWorld Price + TariffQd2Qs2Revenue from TariffMPw + TDeadweight loss ofwelfare from the tariffPriceOutput (Q)Domestic DemandDomestic SupplySupply price from EU supplyQd2Qs2EUPriceSupply price from non-EUQd1Qs1Trade creation – access tocheaper supplies allows alower price – which benefitsconsumersP1A lower price leads to anexpansion of demand and arise in consumer surplus + anet improvement ineconomic welfare
74) UK Trade with the rest of EuropeNearly 55% of UK exports and over half of imports come from the EU. This figure has increased graduallyover the years; a point of contrast is that only 7% of our exports go to the BRIC nations (Brazil, Russia, Indiaand China). Europe is an importance source of inward investment for example money invested in mergersand takeovers, portfolio investment in bonds and property and money flowing into commercial banks.UK exports by destination UK imports by destination1. European Union (27) 53.6 1. European Union (27) 51.52. United States 14.3 2. China 9.43. China 2.8 3. United States 9.04. Switzerland 2.0 4. Norway 4.75. Canada 1.6 5. Canada 2.2UK Trade to GDP Ratio: 58.8%UK joined the WTO on 1stJan 1995Source: WTO Trade Profiles – data is for 2010The UK runs a monthly trade deficit of approximately three billion pounds with the countries inside the EuroArea. This deficit has barely changed over recent years and is a structural feature of our trade patterns. Thelargest trade deficit is with Germany – Europe’s biggest economy and one of the world’s largest exports ofmanufactured products such as household appliances, audio-visual equipment and vehicles.£bn per month, Current Prices, seasonally adjustedUK Exports to and Imports from the Euro ZoneExports to Euro Zone countries Imports from Euro Zone countriesSource: Reuters EcoWin02 03 04 05 06 07 08 09 10 11billions78910111213141516GBP(billions)78910111213141516
85) The European Union Single Market"What we need are strengths which we can only find together. […] We must have the full benefit of a singlelarge market" (Prime Minister, Margaret Thatcher 1986)The single market is a deep form of integration between nations and is built upon four key freedoms:1. Free Trade in Goods: Businesses can sell their products anywhere in the EU’s member states andconsumers can buy where they want with no penalty. Intra-EU trade of goods represents 75% ofintra-EU trade flows. It has increased at an annual rate of 7.6% between 1999 and 2007. Forcountries such as the Czech Republic and Hungary, trade with the EU accounts for over 90% oftheir trade – showing just how important is the single market to their economic fortunes.2. Mobility of Labour: Citizens of EU member states can live, study and work in any other country.The aim is to improve the mobility of labour. For example, every year over 180 000 Europeanstudents move to another Member State for the Erasmus programme or to attend a postgraduate degree. But overall, Europe is an area of low geographical mobility with only 2.3% ofEuropeans living in a Member State different from that of their nationality. This figure is threetimes higher in the United States. An estimated 12m European citizen live in an EU country otherthan their own – equivalent to the population of Belgium or Greece.3. Free Movement of Capital: Currencies and capital can flow freely between member states andEU citizens can use financial services in any member state.4. Free Trade in Services: Professional services such as pensions, architecture, telecommunicationsand advertising can be offered in any member state. Services account for over 70 per cent ofGDP in many EU countries. But progress in expanding intra-EU trade in services has been slow.At present, only 20% of the services provided in the EU have a cross-border dimensionSingle market and economic concepts1. Productivity:a. The EU Single Market is designed to create a “positive sum game” for member states iftrade and competition leads to higher productivity and brings about lower costs forproducers and eventually cheaper prices for consumers.b. Stronger competition encourages industrial restructuring because exposure to othermarkets causes businesses to re-organise their management (improving X-efficiency) tominimise costs2. Lower prices and higher real incomes: Lower prices should boost consumers real livingstandards and an increase in competition will lead to improved allocative efficiency and lesswaste. This might mean for example lower fares for airlines, cheaper prices for mobile calls orreduced costs for car and home insurance if European markets are more contestable.3. Economies of scale: Firms selling in the Single Market have (in principle) unrestricted access toover 500 million consumers in the EU. The size of market allows businesses to exploit economiesof scale leading to improvements in productive efficiency. For example UK retailers such asTesco have successfully made in-roads into the retail markets of many EU countries earningprofits that flow back into the UK. Foreign retailers have entered UK high streets too!
94. Labour mobility: There are economic and social costs and benefits from a freer movement oflabour - these are discussed in a separate section of this revision companion. Migration flowshave increased significantly since ten new member states have joined the EU after 2004.5. Price convergence: Competition should lead to a process of price convergence betweencountries meaning that the gap between what we pay from one country to another for the sameproduct should fall - but there will always be price variations within EU for the same productssuch as basic foods, new cars and products such as iPads and smart-phones.6. Business alliances and joint ventures: The single market encourages cross-border technologicalalliances and joint ventures – boosting dynamic efficiency and competitiveness.7. Economic growth and resilience to external shocks: A stronger internal EU economy with animproving trend growth rate of potential GDP may be less vulnerable to global external shocksand better able to reduce unemployment. The global financial crisis and subsequent recessionthroughout Europe has allowed us to see how resilient the EU single market is.8. In short the single market is designed to accelerate the gains from specialisation and tradebetween participating nations.Economies of ScaleIntra-European TradeKey to all of this is to remember that the EU is a customs union. This means that the EU levies duties onimported goods and services coming into the region. But there is free trade within the market. This causes arise in intra-EU trade. A recent EU report found that Intra-European trade currently accounts for 17% and28% of world trade in goods and services respectively.Taking services as a separate case, over 30% of intra-European trade in services is in the travel industry,followed by transport (around 20%) and insurance and finance (10%). But health care remains largely withinnational borders. There has been some increase in the demand for and willingness to pay for “healthtourism” services (especially treatments that are cheap in Eastern Europe) but little investment bymultinational health care businesses in different EU countries.CostsRevenuesOutput (Q)MESLRACIncreasing return to scale – economies ofscale - falling LRACDecreasing returns –diseconomies of scale
10The Single Market, Investment, Takeovers and MergersWe have seen a lot of cross-border investment. There are many motivations for this including the following:1. Resource seeking – where a business seeks resources which are unavailable in the home country2. Efficiency seeking – e.g. businesses seeking to benefit from a more productive workforce, lowerwages or from the external economies of scale available in a region.3. Market seeking – e.g. investment to take commercial advantage of growing demand in faster-growing emerging market countriesVertical foreign investmentFor example, Nokia produces mobile phone components and batteries in Hungary and assembles phones inGermany and Finland, where it also has research and development facilities.Horizontal foreign investmentFor example car manufacturers investing in several European countriesTakeovers and mergersIn recent years there have been many examples of businesses looking to integrate or form joint ventures toestablish or grow their positions across the EU single market. Here are some recent examples:• Arriva, the UK bus and rail operator was bought by Deutsche Bahn• British Airways merged with Spanish airline Iberia in January 2011 to form IAG• British healthcare group Alliance Boots acquired German drug distributor Andreae-Noris Zahn• Dutch LWM potatoes group agreed a takeover of Austrian frozen food producer Frisch & Frost• Incumbent postal operators, Posten (of Sweden) merged with Post Danmark• Spains Banco Santander acquired Polands Bank Zachodni from Allied Irish Banks• Spanish Bank Banco Santander acquired 318 branches of Royal Bank of Scotland (RBS)• Tesco acquired 128 Penta convenience stores in the Czech RepublicPutting the EU Single Market in ContextThe EU internal market does not operate in isolation. There are many external forces influencing growth,prices, investment and jobs within the EU. The single market has been affected for example by:1. Financial instability – for example the sub-prime mortgage crisis in the United States2. Globalization and the emergence of new powers such as the BRIC countries (Brazil, Russia, Indiaand China) – the balance of power and influence in the world economy is shifting rapidly3. Political changes including the collapse of the Soviet bloc and turbulent international relationsto the east of the European Union for example Russian-Ukrainian relationships4. Increase in labour migrations and in greater cultural diversity around the world5. The technological revolution, triggered by Information and Communication Technology;6. The growing importance of services in the economy and the rise of global digital technologies7. The growing awareness of environmental and climate-change challenges and internationalpressures to introduce policies to address these issues
11Barriers to the successful completion of the EU single marketThe EU market is not complete. Despite claims by politicians, there remain plenty of barriers to and costs ofsupplying goods and services across all twenty seven members of the European Union. Services in particularare seen as an area of the single market that is a long way off allowing genuinely free trade and open access.State Aid: One of the controversial issues during the recession has been extensive use of state aid as a wayof a government supporting and protecting their own interests. Sectors such as the financial industry,airlines, car manufacturers and tourism have been granted billions of Euros in aid to survive the recession. Inthe UK, the RBS received over £45 billion of state aid from the UK government. Aid pledged to Europes banks hits 4.5 trillion Euros (BBC news, December 2010) EU takes Greece to court over tax breaks (BBC news, February 2010) Osborne launches a loan guarantee scheme for banks lending to small and medium-sized enterprisesIntellectual property: At present patents on innovations and invention have to be enforced on a country-by-country basis and this makes the cost of intellectual property protection much higher in Europe than forexample in the United State of Japan. There have been calls for a single European patent law. According tothe Financial Times, patenting an idea in the USA is at least 10 times cheaper than in EuropeLabour mobility: We cover labour migration in a separate section of this revision guide. But in recent yearsseveral EU countries have tightened up their labour migration policies in a bid to control the volumes ofpeople moving into their countries seeking work.Because there are now twenty seven countries in the EU it becomes harder and more time-consuming to getall countries to agree on policies that might help make the single market more complete.Reforming the EU Single Market - The Monti Report – May 2010In June 2010 Professor Mario Monti identified a range of reforms that are required to make the internalmarket work better. He argued that the single market suffers from bottlenecks that prevent truecompetition from being established across every member nation.His suggested reforms include:1. A European Free Movement Card to make it easier for people to move around the EU2. Abolish double taxation of registration for cars so that motorists and car hire firms can movetheir cars more easily across the twenty seven nations3. Greater protection for consumers who buy products from suppliers in other EU countries4. Adopt the Statute for a European Private Company to make it easier to set up new businesses5. Proposal for an EU copyright law and measures to boost EU online broadcasting6. Reforms for EU energy markets including regulatory support for smart metering, smart gridsand transparent wholesale energy markets (especially in gas)7. Step up targeted EU funding for energy infrastructure especially in new member states8. Establish a single market for green products, by developing EU-wide standards for measuringand auditing carbon footprints and for energy efficient products9. Adopt a single European Patent Act to boost research and innovation
126) Price ConvergencePrice convergence means that the gap in prices between different regions or countries for the same good orservice has fallen. An EU single market and nearly ten years of having a single currency ought in theory toprovide the conditions for price variations to come down:1. More intense competition between businesses and less scope for monopoly pricing2. Having one currency ought to make it easier for consumers to compare prices and buy from thecheapest seller because of price transparency3. Developments in web technology also make it easier for price comparisons and buying fromcheaper suppliers.This chart provides some evidence of price convergenceBut despite this there are specific market factors for why the same products often sell for different prices:• Variations in indirect taxes such as VAT and other duties• Geographical location and transport costs – affecting the cost of getting products to consumers• Retailers’ real estate costs including the costs of renting stores• Differences in average wages throughout the EU and variations in minimum wage levels• Differences in per capita incomes within Europe and also variations in consumer price elasticityof demand for different products (this affects the pricing power of manufacturers and retailers)• Uneven degrees of competition – for example the UK food retailing sector is widely regarded ashighly competitive with frequent price wars between the major retail businessesThe lower the figure, the closer are consumer prices for countries within the EUPrice Convergence Indicator for the EUSource: Reuters EcoWin95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 101015202530354045%101520253035404527 nations of the EUCountries inside the Euro Zone
137) Value Added Tax and Corporation Tax in EuropeOne important aspect of the single market is the continued freedom of member countries to set their owntax levels for consumers and businesses. Although there are many senior EU figures who wish to see greatertax harmonisation across countries, the UK position is that decisions on taxation are best left to individualgovernments who often have different economic, social, political and environmental priorities.Tax rates for selected EU countries Corporate tax Standard VAT rateAustria 25% 20%Belgium 34% 21%Bulgaria 10% 20%Czech Republic 21% 20%Denmark 25% 25%Estonia 20% 20%Finland 26% 23%France 33.33% 19.6%Germany 15.8% Federal rate + local rate 19%Greece 25% 23%Hungary 16% 25%Ireland 12.50% 21%Italy 31.40% 20%Latvia 15% 21%Luxembourg 28% 15%Netherlands 25.50% 19%Poland 19% 22%Portugal 27.50% 23%Romania 16% 24%Slovakia 19% 19%Slovenia 20% 20%Spain 30% 18%Sweden 26.30% 25%United Kingdom 21%-28% 20.00%• Some countries have deliberately used lower corporate tax rates as carrot to attract inwardinvestment. Ireland was among the first to try this and succeeded in getting significant amountsof investment from the USA and elsewhere. Many of Europe’s new member states have alsoengaged in “tax competition” to bring in fresh investment. Bulgaria, Hungary and Romania arethree such examples• Once applied to a product, there is a minimum rate of VAT in Europe of 5% and there are alsominimum duty rates for cigarettes.• There are also sizeable differences in excise duties from one country to another – for examplethe duties placed on cigarettes, alcohol and fuel. This directly affects the cost of living in oneEuropean country compared to another.
148) Business Ownership – Privatisation and Nationalisation in the EUThe balance of ownership between public and private sectors within Europe is always changing. This shortsection provides an overview of state and private sectors in some EU countries.PrivatisationPrivatisation means the transfer of assets from the public (government) sector to the private sector. In theUK the process has led to a sizeable reduction in the size of the public sector. State-owned enterprises nowcontribute less than 2% of GDP and less than 1.5% of total employment. Privatisation has become a keymicroeconomic reform in the transition economies of Eastern Europe. But in recent times, privatisation inthe UK has given way to a new wave of nationalisation including some high profile banks, building societiesand transport services. Nationalisation has also happened in other Western European countries.NationalisationThis is where a business (or perhaps en entire industry) is in the partial or whole ownership of the State.Public sector businesses often operate on commercial lines but their objectives may differ from enterpriseslisted on stock markets – usually there is greater weight given to politically important targets and objectives.The scale of state ownership varies across Europe. Germany has a social market economy with a strong private sector underpinned by state ownershipin certain key industries - public sector businesses include government stakes in Deutsche Bahn,Deutsche Post, Deutsche Telekom and Deutsche Postbank. State governments own shares in anumber of companies including carmaker Volkswagen. During the financial crisis the Germanmortgage bank Hypo Real Estate, deemed too important to fail, was taken into full state ownership. French governments have traditionally played an important role in industry, arranging takeoversand mergers and offering financial support (including whole or partial ownership) in a number ofbusinesses. Examples include Although Frances state-owned nuclear corporation, Areva SNCF (thestate-owned train operator) EDF energy, France Télécom, EADS (owner of Airbus) and Renault. In many eastern European countries the collapse of communism in the late 1980s and early 1990sbrought about wholesale privatisation of many state assets. And this part of the transition processhas continued since many CEE nations joined the European Union in 2004 and 2007. In Poland forexample, the number of enterprises in which the government holds stakes fell to 1,090 at the end of2009 from more than 8,400 in 1990.Here are some examples of planned privatisations among this group of countries:1. Bulgaria plans to privatise the state-owned cigarette maker Bulgartabak2. Croatia is selling off six loss-making shipyards - a key condition for progress in EU accession talks3. The Czech Republic is selling off the state-owned Czech Airlines and Prague Airport4. The Hungarian government wants to privatise drug maker Gideon Richter5. Poland is privatising firms in the telecoms and energy sectors
15Nationalisation in Britain: Public sector businesses include:1. Network Rail - a "not for dividend" company that owns the fixed assets of the UK railway systemEast Coast Rail Line - a train operating company nationalised in June 20092. Royal Mail Ltd - Royal Mail has been a state-owned company since 1969. The Coalition Governmenthas plans to part-privatise the Royal Mail in the near future. The Royal Mail Group includes PostOffices and the Parcel Force business3. Bradford and Bingley - In 2008 the government took control of the banks £50bn mortgages andloans, while B&Bs £20bn savings unit and branches was bought by Spains Santander Bank4. Royal Bank of Scotland (RBS): On the 13 October 2008 the government bailed out the bank in returnfor a 70% stake in it. The government also has a 43 per cent stake in Lloyds Banking Group2011 Developments: In July 2011, the state-owned Tote bookmakers was sold to betting firm Bet Fred Northern Rock plc was nationalised in 2008 after becoming the first commercial bank to suffer adepositor run for more than 100 years. After a few years in state-ownership, on 17 November 2011Virgin Money announced an agreement to buy Northern Rock plc for £747 million up front and otherpotential payments of up to £280 million over the next few yearsAirlines in Europe – the controversy over state aidIn many EU countries the government owns a sizeable or a controlling stake in one or more airlines. Theseare known as flagship carriers with strategic significance even if many suffer heavy losses. Austrian Airlines 40% Belgium - Sabena 34% Cyprus - Cyprus Airways 69% Czech Republic - CSA Czech Airlines 94% Denmark - Scandinavian Airlines 50% Finland - Finnair 60% France - Air France 18% Greece - Olympic Airlines 100% Ireland - Aer Lingus 25% Italy - Alitalia 50% Netherlands- KLM Royal Dutch 6% Poland - LOT Polish Airlines 68%The recession hit the aviation industry hard bringing about growing losses for many airlines. Global airlinesmade losses of $9bn in 2009 due to falling revenues and rising costs including expensive aviation fuel prices.In Europe, a fall in passenger and cargo demand resulted in significant losses for many carriers and therestructuring of the sector. The downturn in average fares, passenger numbers and freight has put the issueof state support for some European airlines into the spotlight.The restructuring took the form of intensified horizontal cooperation within global airline alliances resultingin joint venture agreements covering transatlantic routes. There were also some important mergersinvolving large network carriers such as Delta/Lufthansa and British Airlines joining up with Iberia (Spain)An association of (largely profitable) low-cost airlines in Europe such as FlyBe, easyJet, Jet2 and RyanAir hascomplained to the EU commission that government support to established airlines is in breach of EUcompetition laws on state aid. Emergency support is allowed under EU rules for the rescue and restructuringof firms in difficulty. But repeated flows of funding are not allowed - indeed state aid can only be grantedonce over a 10-year period. The low cost airlines complain that state owned and subsidised airlines are aform of indirect protectionism in the EU aviation industry.
16Losses for airlinesThe diagram below provides a simple analysis of when airlines suffer losses. At the profit maximising outputQ1 the average cost of production is greater than the average fare leading to a loss per unit.Should EU governments provide financial assistance to loss-making airlines?The case for state aid / subsidy:1. If airlines go bust many thousands of well-paid and highly-skilled jobs will be lost in the aviationindustry – both in the airlines, manufacturers of aviation equipment and in related service industries2. These job losses and corporate failures will bring about negative multiplier and accelerator effects3. Aid funds rescue & restructuring for the airline industry for the long run benefit of the EU economy4. The circumstances facing airlines are uniquely difficult – credit crunch, avian flu, volcanic ash, highlyvolatile oil prices, terrorist threats – and justify some support to maintain a stable aviation industryArguments against state aid:1. There is little market failure here that might justify state financial support. Subsidising loss-makingairlines distorts the market and is inequitable to other profit making airlines2. It gives one airline an advantage over others and goes against the principles of the single market3. If airlines are state owned and bailed out this might cause a loss of dynamic efficiency and theproblem of moral hazard (the knowledge that risks can be taken because support is there)4. Billions of Euros of state aid have an opportunity cost and might be better spent in alternatives suchas improving high-speed rail networks. Either way – the EU taxpayer eventually pays for this.5. If airlines are given special state help why not other industries? Aid doesn’t solve structural problemsfacing the EU aviation industry.
179) Measuring the Standard of Living within the EU1. The base line measure of living standards is real per capita national income adjusted to expressthe data at a purchasing power standard2. GDP per capita in the EU Member States ranged from 44% to 271% of the EU27 average in 20103. Luxembourg has the highest per capita incomes whilst Ireland, Denmark, Austria and Swedenare between 20% and 30% above the EU27 average. The United Kingdom registered GDP percapita around 10% above the EU27 average, while Italy, Spain and Cyprus were at the average4. Hungary, Estonia, Poland, Lithuania and Latvia were between 35% and 50% lower, whileRomania and Bulgaria were around 55% below the EU27 average.GDP per capita is a flawed measure of living standards. Official measures of living standards ignores1. The informal economy where products are not traded at officially measured market prices2. The size of the illegal shadow economy3. Length of the working week and the standard of employment conditions4. Extent and cost of externalities from consumption and production5. Income & regional inequality factors including differences in Gini Coefficient6. Quality of life variables such as educational and health provision; the quality and availability ofpublic services, the risk of crime and various indicators of social exclusion and deprivation7. Levels of disposable income – variations in direct and indirect taxationGDP per head, purchasing power parity adjusted, EU27=100Per Capita GDP for selected EU CountriesSource: Reuters EcoWin99 00 01 02 03 04 05 06 07 08 09 108090100110120130140150EU27=1008090100110120130140150GermanyUKItalySpainGreeceIreland
18Consumption per headThis is an alternative approach to measuring relative living standards – i.e. the ability of households toconsume goods and services regardless of whether or not they have to pay for them. The EU now publishesdata on this and for 2010 they found that consumption per capita in the UK was 20% above the UK averagewith Britains rating boosted by public services such as health and education – largely government funded.Bulgaria (who joined the EU in 2007) was judged to have the lowest standard of living, 58pc below that ofthe EU average.Consumer prices in EuropeThis data is used to help estimate purchasing power parity measures of income and consumption per head.Retail prices in the UK were 2% above the EU27 average in 2010, while Denmark was the most expensive at47% above the average. Bulgaria was the least expensive, at 55% below the average.Income inequality in EuropeData on income per head gives us a sense of average living standards. But mean incomes per head of thepopulation tend to hide what can be deep and extensive inequalities in income and wealth.A commonly used measure of income inequality is the Gini coefficient, which is based on the cumulativeshare of income accounted for by the cumulative percentages of the number of individuals, with valuesranging from 0 per cent (complete equality) to 100 per cent (complete inequality). As our table below shows,the estimated Gini coefficients in Europe vary a lot across countries.Selected EUcountriesGini Coefficient(data for 2008)Gross domestic product perhead, PPP adjusted, datafor 2009Comparative pricelevels in 2009 (EU-27=100)Median HouseholdEarnings Thousand Eurosper year in 2008Portugal 0.38 80 87 11Greece 0.36 93 97 19Italy 0.36 104 107 26United Kingdom 0.36 112 96 35Poland 0.35 61 54 6Spain 0.35 103 98 19Ireland 0.34 127 131 36Belgium 0.33 116 118 34France 0.33 108 114 26Romania 0.32 46 51 3Netherlands 0.31 131 110 30Hungary 0.30 65 59 6Bulgaria 0.29 44 44 1Germany 0.28 116 105 34Finland 0.27 113 125 29Czech Republic 0.26 82 65 8Denmark 0.25 121 150 43Sweden 0.25 118 112 30
1910) Enlargement of the European UnionThe expansion of the EU to embrace more countries has been perhaps the most important development inEurope in many years. There have been six main waves of enlargement. 1973 (UK, Ireland and Denmark) 1981 (Greece) 1986 (Portugal and Spain) 1995 (Austria, Finland and Sweden) 2004 (Latvia, Lithuania, Cyprus, Malta, Slovenia, Slovakia, Estonia, Hungary, Czech Republic, Poland) 2007 (Accession of Bulgaria and Romania)Advantages for new EU countriesFor new EU members the opportunities of participating in the EU single market have been centred onattracting high levels of inward investment, and promoting development through free trade access to thehigher-income consumers of richer EU nations. Inward investment was attracted to countries with lowrelative unit labour costs and where expected growth of per capita incomes was high.In addition they have been recipients of EU funding -- which have financed road construction,environmental clean-up schemes, job training and other supply-side projects.Index of GDP per head, purchasing power standard, EU=100Income convergence for ten new EU membersCzech RepublicHungaryPolandSloveniaEstoniaSlovak RepublicBulgariaLithuaniaLatviaRomaniaSource: Euro Stat00 01 02 03 04 05 06 07 08 09 102030405060708090100EU27=1002030405060708090100
20As our chart shows there has been limited progress in achieving convergence in per capita incomes althoughprogress towards income convergence has been stalled because of the effects of the recent recessionThe macroeconomic performance of new EU nations Enlargement occurred during a period of strong growth (driven by a rapid expansion of exports in anera of globalisation) and the boost from low inflation and interest rates. One can argue that this wasan opportune time to widen the EU single market – macroeconomic conditions were favourable. But progress made by new EU members has not been even – most have achieved a degree ofincome convergence and have managed to bring down unemployment levels. But there have alsobeen underlying problems – notably property bubbles, rising consumer debts, high inflation,current account deficits on the balance of payments and the effects of depopulation as migrantworkers from central and eastern European countries in particular moved west in search of workand higher incomes. To these short term problems we can add the issues of an ageing and decliningpopulation in many eastern European countries.The global credit crunch and ensuing international slowdown and recession hit the EU hard and the impactspread into many new member states. Many suffered a deep recession and their first major downturn sincethe post-communist chaos of the early 1990s. This created severe economic, social and political problems.The worst-affected countries were heavily dependent on the Euro Area for investment and exports but wereeventually helped by a fall in their exchange rate against the Euro in 2009.Several new member states allowed a property bubble to develop in the early years of the current decade.The recession in these countries was made worse by property price deflation and also by large borrowingmade in Euros. Many of their currencies depreciated against the Euro - making it harder to service debtissued in Euros – and some currencies outside of the Euro have come under speculative attack. There hasalso been a partial loss of investor confidence in central and Eastern Europe – leading to some reversal ofFDI flows – which have been a major source of growth and new jobs over recent years.Country Focus: PolandPoland Macro Indicators 2007 2008 2009 2010 2011Real GDP (% change) 6.8 5.0 1.7 3.5 4.0Consumer spending (% change) 4.8 5.3 2.6 2.5 3.0Capital investment (% change) 17.3 9.7 -0.7 -0.6 17.8Exports (% change) 9.1 5.8 -6.0 11.6 5.8Imports (% change) 13.7 6.2 -13.2 11.7 8.4Unemployment rate (% of the labour force) 9.6 7.1 8.2 9.6 8.9Fiscal balance (% of GDP) -1.9 -3.7 -6.8 -7.9 -6.7Official policy interest rates (per cent) 4.8 6.3 4.3 4.1 5.6Consumer price inflation (per cent) 2.4 4.2 3.8 2.4 2.5Balance of Payments Current Account (% of GDP) -4.7 -4.8 -2.2 -2.4 -3.2Poland is the largest of the new members of the EU and is widely regarded as having avoided the worsteffects of the global financial crisis and European recession. As the table shows, real GDP growth slowedsharply in 2009 from the 5 per cent plus annual growth rates achieved in the first half of the decade. But afull-blown recession was avoided and growth recovered strongly in 2010 and 2011. Poland’s economy has
21been consistently growing during the European crisis although their economy is not isolated from thedifficulties in the Euro Zone.One reason for Poland’s relative success during 2009-10 was depreciation in the external value of theircurrency – the Zloty. The fall in the value of the Zloty (after a number of years when the Polish currencyappreciated against the Euro) helped to boost the price competitiveness of Polish exports within the EUsingle market at a time when European trade was weak because of the recession. The Polish central bankwas also able to cut official policy interest rates from 6% to 4% and the government’s budget deficitexpanded to over 6% of GDP as their fiscal stimulus kicked-in.The result has been a relatively stable outcome for Poland. Their inflation rate is under control and exportsrebounded strongly in 2010 with an increase of nearly 12 per cent. Progress in reducing unemployment hashalted because of the slowdown but Poland has not suffered the steep rise in jobless totals of some fragileEuro Area countries such as Spain, Ireland, Italy and Greece.“Poland’s proximity to Germany and a cheap, qualified workforce has made it a natural destination for investors. In1991 – the last year in which Poland’s economy contracted – GDP per capita in current dollar terms was $5,612(€4,212), according to the International Monetary Fund, about a quarter of the level in Germany. Last year, Poland’sGDP per capita was $18,981, about half of Germany’s.” Source: FT review of the Polish economy, 2011Recently Poland has been re-classified by the World Bank as a high-income country. It remains an attractivelocation for inward investment and seems to have established itself well within the single market. The newlyelected Polish government is committed to joining the Euro because they believe it is an integral part of theEuropean project. That said being outside of the Euro Zone may have helped the Polish economy to weatherthe worst of the effects of the financial crisis in recent times.Top Pane: Real GDP Bottom Pane: Effective Exchange Rate IndexPoland - Growth of Real GDP and the Exchange RatePoland, Real GDP, precentage change from previous period, Constant PricesEffective Exchange Rate IndexSource: Reuters EcoWinJan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct07 08 09 10 11859095100105110115120125130Index85909510010511011512012513001234567Percent01234567Poland - Real GDP Growth Rate
22The long term progress of Poland in lifting productivity and incomes per head is shown in the chart belowThe Polish economy is a good example of a country that has benefitted from EU structural funds to helpfinance much needed capital investment. Poland currently receives €67bn over a 5 years period in structuralfunds from the EU budget. Much of this money is allocated to addressing a deep infrastructure gap includinga very poor road and rail network. In 2011, about 250km of motorways will be completed, with the mostimportant segment being a 105km section that will finally link the German border with the central Polish cityof Poznan. Poland is the only EU country not to have been in recession in the past 20 yearsPoland’s Trade ProfileNote here how dependent Poland is for her trade with the European Union. Nearly 80% of exports are soldto fellow members of the EU contrasted with 55% for the UK. Less than 2% of exports go to the USA.Poland’s exports by destination Poland’s imports by destination1. European Union (27) 79.4 1. European Union (27) 61.62. Russian Federation 3.7 2. China 9.23. Ukraine 2.5 3. Russian Federation 8.64. Norway 1.9 4. South Korea 3.05. United States 1.8 5. United States 2.3Trade to GDP Ratio: 82.2%Poland joined the WTO on 1stJan 1995Source: WTO Trade Profiles – data is for 2010Annual figuresPoland - Progress in lifting Productivity and Income Per HeadGDP per Capita in PPS Labour Productivity per Person EmployedSource: EU Commission95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 1040.045.050.055.060.065.070.0EU27=10040.045.050.055.060.065.070.0Labour productivity relative to EU average (EU27=100)Income per head relative to EU27 average (100)
2311) EU Enlargement and the impact on the UK economy“Eastward enlargement has been one of the EU’s greatest successes. By opening its doors and stretching out a helpinghand, the EU has contributed to transforming 13 central and eastern European countries from post-communistconfusion into open market, well-functioning democracies. Of course the EU’s new members aren’t perfect; the 2008-09global financial crises have laid bare their weaknesses. The fight against corruption, cronyism and crime has slowed insome places, and massive investments in skills, technology and infrastructure are still needed to bring the easternEuropeans up to western European living standards. There is no doubt that people in the new EU countries live longer,healthier, happier and more secure lives than they would otherwise enjoy”(Source: Katinka Barysch, Chief Economist of Centre for European Reform)Advantages of EU enlargement for the UKThe UK government favours bringing more countries into the EU partly because of a belief that the UK’seconomic performance can improve as a result (economists term this a “positive-sum game”). Among thebenefits cited from having more countries within the market here are four key ones:(1) Export Potential: There are trade creation effects from increasing the size of a customs union.Britain can now source some of her imports of goods and services more cheaply leading to animprovement in her terms of trade. Efficiency should increase as resources are diverted to areasof the UK’s comparative advantage.(2) Exploitation of economies of scale from supplying to a larger market: As the size of theEuropean market increases and accession countries become richer creating new demand forExports of goods and services, annual data, current prices, £ billionUK Exports to some new EU StatesPolandSlovakiaHungaryCzech Republic00 01 02 03 04 05 06 07 08 09 10billions0.00.51.01.52.02.53.03.54.04.55.0GBP(billions)0.00.51.01.52.02.53.03.54.04.55.0These countries joined the EU in May 2004
24goods and services. For example, the value of British exports to Poland (at current prices) hasmore than doubled since Poland’s accession to the EU in 2004 reaching nearly £5bn in 2010(3) Foreign Investment and Incomes and Profits: Foreign investment by British firms into Europe’snewest states will provide a flow of interest profits and dividends thereby boosting our GNP andsupporting the current account of the balance of payments. FDI will also help to speed up theeconomic transformation of Europe’s new countries.(4) A more diverse European labour market: There are now greater opportunities for Britishbusinesses to import lower-cost skilled labour in areas where there are labour shortages. Themigration of labour from accession countries was larger than many economists predicted in2004 but during the strong growth years of 2005-2008, inward migration into the UK helped tooffset some of the longer-term effects of ageing populations and the slow growth of thepopulation of working age. It kept wage inflation and consumer price inflation lower than wouldotherwise be the case and may have contributed to a higher level of potential national income.Risks of EU Enlargement for the UK(1) Extra budgetary costs for financing EU programmes – most of the new member states of the EUare relatively poor in terms of real GDP per capita and the EU has raised the size of theirspending on cohesion funds much of which has been targeted at relatively poorer countries andregions.(2) Social and economic pressures from inward labour migration – this is covered in a separatechapter(3) A shift or displacement of foreign direct investment and jobs to Eastern Europe – partly drivenby tax competition and by lower unit labour costs.Next StepsThe EU will enlarge further in future years but the pace of this is open to question in the wake of the globalfinancial crisis. There are numerous pre-entry conditions that have to be met by any country seeking EUmembership, but it seems that Croatia’s entry into the EU will pass through relatively untroubled. And therehave been some suggestions that Iceland might seek entry to the single market. In July 2009 Icelandformally submitted an EU membership application. Effectively it is already part of the single market and overseventy per cent of its trade is with other EU countries. Serbia, Albania and Montenegro are also candidatecountries to expand the single market to thirty countries or more.But the biggest and most controversial enlargement would be that of Turkey.After several years of discussion, negotiations between the EU and Turkey seem to have stalled for the timebeing. Turkey does not recognise the legitimacy of the Greek Cypriot government but the EU insists thatTurkey opens its ports and airports to ships and planes coming from Cyprus. Turkey is insisting that EU takessteps to end the isolation of the Turkish Cypriots, such as allowing them to trade freely with EU countries.Human rights remain an intractable issue between the politicians. Finland, Italy, Sweden, Spain and the UK,remain strongly in favour of Turkish membership. The Dutch, Austrians and Germans are more sceptical.Although Turkey remains outside of the EU – it does share with them a common external tariff arrangement.
2512) Movement of Labour within the EU“Since 2004 an estimated one million Poles have settled in Britain, taking advantage of the higher wages Britishemployers were prepared to pay. They became so much a part of the country’s life that Tesco, Asda and Sainsbury’s andsmall local shops—started stocking Polish food and drink, and libraries began to stock books and newspapers in Polish.… …Polish builders, with a reputation for working long hours at a fraction of the price local workers charge, has spentfour years forcing their British rivals to raise their game.” (Source: The Times Newspaper, February 16, 2008)Inward migration into the UKFor most of this decade, Britain has experienced a significant level of net inward migration, where manymore people were coming into the UK to live and work than were leaving. Many of these people have cometo the UK from other EU countries especially the new member states of Eastern Europe. Free movement oflabour is one of the guiding principles of the EU single market. So in 2004 when the eight Central Europeancountries Czech Republic, Estonia, Hungary, Latvia, Lithuania, Slovenia, Slovakia and Poland joined the EU adebate started about immigration into the UK that has barely stopped since.Basic data on inward migration from Central and Eastern European CountriesOfficial data shows that between 2004 and the firstquarter 2009, the share of immigrants from thesecountries as a proportion of the UK population increasedfrom 0.01% to 0.9%, comprising 1.3% of the working agepopulation in 2009. The data shows that EU immigrantsare substantially younger and better educated than thenative population.Nearly two thirds of the migrants coming to the UK fromcentral and eastern European countries have been fromPoland. The number of migrants from Poland has startedto decline but in the spring of2010 there were still overhalf a million Pole living in the UK.Many factors affect the rate of migration. Some of themare summarised below. In general, the incentive to migrate is strongest when the expected increase inearnings exceeds the cost of relocation.(1) Differences between countries in wages and salaries on offer for equivalent jobs(2) Access to the benefits system of host countries plus state education, housing and health care(3) Employment opportunities vary between nations, in particular for younger workers(4) A desire to travel, learn a new language and pick up new skills and qualifications(5) A desire to escape political repression and corruption in the country of origin(6) The impact of satellite television and the internet in changing people’s expectations(7) The effects of cheaper phone calls and more affordable air travel and coach travel(8) The unwillingness of people within the domestic economy to take certain “drudge-filled” jobssuch as porters, cleaners and petrol attendants
26The effects of labour migration on the labour markets of richer nations inside the European Union includingthe UK depend on where the main source of competitive advantage lies, according to research fromMarques and Metcalf in a paper delivered to the Royal Economic Society. They argued that industries thatsource their competitive advantage from a large,skilled workforce will have gained from an influxof younger, well-educated workers. Industriessuch as high-knowledge manufacturing,transportation and financial services may wellgain from an increase supply of skilled workersfrom Eastern Europe.In contrast industries that rely on low-educatedlabour-intensive workers will lose out becauseproduction will gravitate to countries where unitlabour costs are lower. Examples of includetextiles and clothing and leisure sectors wherethere has been a shift of production towardsemerging economies in the Far East.Source: Office for UK National Statistics: http://www.statistics.gov.uk/cci/nugget.asp?id=260 accessed Dec 2010Has migration from other EU countries benefitted the UK?Have migrant workers provided a boost to the competitiveness and supply-side capacity of the UK economy?The debate will rage on for many years and it is important to be aware that with this kind of controversialissue, many of those putting forward evidence will be using normative economics heavily laden with valuejudgements and will often use data selectively to push their own point of view.Supporters of inward migration have argued that migration provides:(1) Fresh skills: Migrants can provide complementary skills to domestic workers, which can raise theproductivity of both (a child minder from the Czech Republic provides good quality child care atan affordable price which allows a highly paid female magazine editor to continue to work.)(2) Driver of innovation and entrepreneurship: Inward migration can also be a driver oftechnological change and a fresh source of entrepreneurs. Much innovation comes from thework of teams of people who have different perspectives and experiences.(3) Multiplier effects: New workers create new jobs, there is a multiplier effect if they find work andcontribute to a nation’s GDP through a higher level of aggregate demand.(4) Reducing labour shortages: Migration can help to relieve labour shortages and help to controlwage inflation. This can reduce the non-accelerating inflation rate of unemployment (NAIRU.)(5) Income flows: Remittances sent home by migrants can add substantially to the GNP of the homenations. And if these remittances boost spending in these countries, this creates a fresh demandfor the exports of other nations.(6) Tax revenues: Legal immigrants in work pay direct and indirect taxes and are likely to be netcontributors to the government’s finances.
27Opponents of unrestricted migration argue that high levels of inward migration create economic and socialtensions and costs for the host economy – some of their points include:(1) Welfare costs: Increasing cost of providing public services as migrants come into a country.(2) Worker displacement: Possible displacement effects of domestic workers – in crude terms this isthe argument that migrants take the jobs of workers in the host country. Anti-immigrationlobbyists have highlighted the correlation between immigration and high youth unemploymentin the UK economy(3) Wage cuts: By increasing the size of the total available labour supply, migrant workers maylower the wages of people in other jobs.(4) Social pressures: Social tensions arising from the problems of integrating hundreds of thousandsof extra workers into local areas and regions.(5) Pressure on property prices: Rising demand for housing which forces up prices and rents.(6) Poverty risk: Migration may have the effect of worsening the level of relative poverty in asociety. And many migrant workers have complained of exploitation by businesses that havemonopsony power in a local labour market.The benefits and costs of labour migration are hard to quantify and estimate. Much depends on• The types of people who choose to migrate from one country to another.• The ease with which they assimilate into a new country and whether they find regular jobs.• Whether a rise in labour migration stimulates capital spending by firms and by government.• Whether workers who come into a country decide to stay in the longer term or whether theyregard migration as essentially a temporary exercise (e.g. to gain qualifications, learn someEnglish) before moving back to their country of origin.Recent empirical evidence from a variety of academic sources finds that the net effects of inward migrationto the British economy have been broadly positive but perhaps not as large as many expected.• The effect on the UK’s trend growth rate has been small• There has been little negative effect on average wages and unemployment among native workers• The net impact on government finances has been positive; the UCL research finds that in the year toApril 2009 workers from eastern Europe paid £1.37 in taxes for every £1 of services they usedThe EU Financial Crisis and Outward Migration from the PIIGS CountriesHigh unemployment especially among the young and falling real living standards brought about by highertaxes, lower government spending and falling wages has prompted a rise in the levels of net outwardmigration from many struggling EU countries in 2010 and 2011. A report in the Guardian in December 2011found that “Tens of thousands of Portuguese, Greek and Irish people have left their homelands this year,many heading for the southern hemisphere. Anecdotal evidence points to the same happening in Spain andItaly.”
2813) Unemployment in the European UnionThe European Union has struggled to bring down unemployment on a sustained basis for nearly twentyyears. Many EU countries have persistently high jobless rates and the problem has deepened because ofrecession. But much of the unemployment in Europe is structural rather than cyclical. Our chart belowtracks unemployment rates in the Euro Area and three members of the currency union – Greece, Spain andIreland. All three of these countries have suffered a steep increase in unemployment rates with Spainexperiencing the worst unemployment rates and a deep problem facing younger workers.In the autumn of 2011 the scale of the unemployment problem in the EU was as follows: The EU271 unemployment rate was 9.8% in October 2011 - it was 9.6% in October 2010 23.554 million men and women in the EU27 were unemployed in October 2011.Compared withOctober 2010, unemployment rose by 440 000 in the EU27 the majority of which came in the 17nations of the Euro Zone Lowest unemployment rates were in Austria (4.1%), Luxembourg (4.7%) and the Netherlands (4.8%) Highest unemployment rates were highest in Spain (22.8%), Greece (18.3%) and Latvia (16.2%) In October 2011, 5.482 million young persons (under-25s) were unemployed in the EU27 and theyouth unemployment rate was 22.0% in the EU27. The highest youth unemployment rates were inSpain (48.9%) and Greece (45.1% in August 2011).Percentage of the labour force, seasonally adjustedUnemployment in Euro Zone, Greece, Spain and IrelandSource: Reuters EcoWinJan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep06 07 08 09 10 110.02.04.06.08.010.012.014.016.018.020.022.0Percent0.02.04.06.08.010.012.014.016.018.020.022.0Euro AreaIrelandGreeceSpain
29Our chart above shows the effect of a deep recession in the Euro Zone on the rate of unemployment. RealGDP fell by more than 4% in 2009 and the unemployment rate climbed from 7.6% in 2009 to over 10% in2010 – mass unemployment returned to the single currency areas and this brings with it many economic,social and fiscal costs.Much of the unemployment in Europe is structural in nature – i.e. it results from problems on the supply-side of the labour market not least difficulties in matching jobless people with the skills required in industriesthat are taking on more employees. The natural rate of unemployment is based on an estimate of frictionaland structural unemployment – high natural rates of unemployment in Europe have many causes including:1. Geographical and occupational immobility of labour2. Employment laws that may raise the cost of employing extra workers especially among small tomedium size enterprises3. Disincentives to look for and take work built into the tax and benefit systems i.e. possibleunemployment and poverty trapsMany regions in Europe suffer from chronically higher rates of unemployment and some of them have doneso for decades. In Europe’s 271 regions, 28 had an unemployment rate of 4.4% or less in 2009 but thirteenregions had a rate of 17.8% or higher - double that of the EU27 average. Europe’s regional policies have akey aim of stimulating enterprise, investment, jobs and incomes in these poorer regions. In the period from2007 to 2013, regional spending accounts for 36% of the EU budget although many have pressed for more –paid for by reforms to the CAP. The 12 countries which have joined since 2004 receive 51% of total regionalspending between 2007 and 2013 including help in funding investment in environmental and transportinfrastructure projects.Left hand scale: Real GDP growth Right hand scale: Unemployment rate (%)Euro Zone Growth and Unemployment RatesEuro Zone, Real GDP, precentage change from previous period, Constant PricesEuro Zone, Standardised unemployment ratesa, per cent of labour force, SASource: OECD World Economic Outlook and Euro Stat03 04 05 06 07 08 09 10 11Unemploymentrate(%oflabourforce)7.07.58.08.59.09.510.010.511.011.5RealGDPgrowth(annual%change)-5-4-3-2-101234
3014) Policies addressing Income Inequalities in the EUThe European Union consists of twenty seven nations with widely differing levels of per capita incomes -even when adjusted for differences in the cost of living. And there are huge differences in incomes per head,median earnings and employment rates within the regions of the EU. Income inequality can be measured invarious ways and one of these is the Gini coefficient.Some economists claim that income and wealth inequality within the EU has increased over the last decadeor so. The forces of globalisation have certainly put pressure on real wages and job prospects in manyregions of Europe where productivity is relatively low and competitive advantages are thin on the ground.Data from Euro Stat showed that in 2010, over 100 million people in Europe were at-risk-of poverty orexclusion (23% of the EU’s total population).The recession and financial crisis has worsened relative poverty within Europe and the issue has becomemore important as public support for European institutions has dropped sharply. The EU unemployment ratenow stands at about 10%, up from 7% in 2008, and the risk of persistent long-term unemployment, povertyand social exclusion will remain high for some time to come. Many people in Europe are worried about thegrowing gap between rich and poor and are looking to national governments to intensify their efforts tolower poverty rates.What are the main policies to reducing income inequalities within the EU? Several strands can be identified:(1) Policies designed to raise productivity levels - because this should allow wages to rise withproductivity to give workers an equitable share in economic growth(2) Welfare policies providing sufficient income transfers for the poorest families - for example,state pensions, unemployment benefit and sickness benefits. Some European governmentsallow these benefits to rise with the annual growth in per capita incomes. Others link benefitlevels to changes in consumer prices which risks causing the relative value of benefits to fall(3) Minimum wage legislation - at present there is no harmonised minimum wage policy acrossEurope. Member countries are free to set their own pay floors or not to have one at all.Minimum wage rates differ quite a lot across EU nations(4) Changing the structure of taxation - this provides a key method of reducing the gap betweenhighest and lowest income families. Progressive taxation — taxes that take a bigger share of theincome of rich families than poor families — tend to reduce income inequality and some EUcountries have chosen to introduce high marginal tax rates for top earners and also makestronger use of means-tested welfare benefits.(5) Macroeconomic stimulus policies: The biggest cause of poverty is unemployment so theeffectiveness of economic stimulus policies in maintaining demand and jobs will be crucial inproviding people with the opportunity to earn extra income. Most EU governments haveintroduced fiscal stimulus measures since 2008 but their freedom to do this is limited by highlevels of government debt and the rising cost of servicing the interest payments on borrowing.The European Central Bank has cut interest rates to 1 per cent but has not many more options toexpand demand other than quantitative easing and perhaps an attempt to drive down theexternal value of the Euro.Ultimately Europe as a region needs to find new sources of growth driven by innovation and enterprise.
31Minimum Wage Rates in the European UnionThe table below tracks minimum wage rates across most EU countries. The best way of ranking the relativegenerosity of the pay floor is to adjust for differences in living costs and express at purchasing powerstandard. A familiar picture emerges; minimum wages are substantially lower in Europe’s newer memberstates where average wages are lower – notably Romania and Bulgaria.Minimum Wage Euros permonth for full time workersPPS Adjusted Value of theMinimum Wage (Euros permonth for full time workers)Hourly labour costs Eurosper hour in 20072004 2009 2009Luxembourg 1,403 1,642 1,413 33.00Netherlands 1,265 1,382 1,336 27.41Belgium 1,186 1,388 1,254 32.68France 1,113 1,321 1,189 25.25United Kingdom 1,084 1,010 1,154 27.19Ireland 1,073 1,462 1,153 Not availableMalta 541 635 810 8.69Spain 537 728 760 16.39Slovenia 471 589 710 12.09Portugal 426 525 606 11.32Poland 177 281 468 6.78Czech Republic 207 306 443 7.88Slovakia 148 296 409 6.41Hungary 200 270 408 7.13Estonia 159 278 362 6.60Lithuania 125 232 347 5.09Latvia 121 254 343 5.42Romania 69 153 263 3.41Bulgaria 61 123 240 1.89Material deprivation – an alternative perspective on povertyInequality and poverty is not simply a reflection of low incomes. The causes and experience of poverty iscomplex and many communities and regions have suffered from deep-rooted poverty for many years.The EU now measures material deprivation as a broader measure of people at-risk of poverty. According torecent figures in the EU27 in 2009, 42 million (or 8% of the population) were severely materially deprived,meaning that they had living conditions constrained by a lack of resources such as not being able to afford topay their bills, keep their home adequately warm, own a car or a telephone etc.The shares of those materially deprived varied significantly among Member States, with the highest inBulgaria (41%) and Romania (33%), and the lowest in Luxembourg, Sweden, the Netherlands, Denmark andSpain (all less than 3%).
3215) EU Competition PolicyThe aim of competition policy is to promote competition; make markets work better and contribute towardsimproved efficiency in individual markets and enhanced competitiveness of UK businesses within theEuropean Union single market. Competition policy aims to ensure Wider consumer choice and improved service Technological innovation Effective price competition between suppliersIf these can be achieved then gains can be made in allocative, productive and dynamic efficiencyThe main jobs of competition policy1. Antitrust & cartels: This involves the elimination of agreements that seek to restrict competitionincluding price-fixing and other abuses by firms who hold a dominant market position (definedas having a market share in excess of forty per cent).2. Market liberalisation: Liberalisation involves introducing competition in previously monopolisticsectors such as energy supply, postal services, telecommunications and air transport.3. State aid control: Competition policy analyses examples of state aid measures to ensure thatsuch measures do not distort competition in the Single Market4. Merger control: This involves the investigation of mergers and take-overs between firms (e.g. amerger between two large groups which would result in their dominating the market).The Role of the RegulatorThe EU Competition Commission is a regulator of business activity in the single market. Key roles are:1. Monitoring and regulating prices: Regulators aim to ensure that companies do not exploitmonopoly or oligopoly / duopoly power by charging excessive prices. They look at evidence ofpricing behaviour and also the rates of return on capital employed to see if there is evidence of‘profiteering.’ Recently the EU Competition Commission made a ruling on the ‘roaming’ chargesof mobile phone operators in the EU and enforced a new maximum price on such charges.2. Standards of customer service: Companies that fail to meet specified service standards can befined or have their franchise / licence taken away. The regulator may also require thatunprofitable services are maintained in the wider public interest e.g. BT keeping phone boothsopen in rural areas and inner cities; the Royal Mail is still required by law to provide a uniformdelivery service at least once a day to all postal addresses in the UK3. Opening up markets: The aim here is to encourage competition by removing or loweringbarriers to entry. This might be achieved by forcing the dominant firm in the industry to allowothers to use its infrastructure network. A key task for the regulator is to fix a fair access pricefor firms wanting to use the existing infrastructure. Fair both to the existing firms and alsopotential challengers. Opening up markets means making them more contestable.4. The surrogate competitor: Regulation can act as a form of surrogate competition – attemptingto ensure that prices, profits and service quality are similar to what might be achieved incompetitive markets.
33In a nut-shell the role of competition authorities around the world including the European Union is toprotect the public interest, particularly against firms abusing their dominant positions - A firm holds adominant position if its power enables it to operate within the market without taking account of the reactionof its competitors or of intermediate or final consumers.Case study: EU competition commission enforces price cap on mobile phone chargesThe EU Competition Commission has enforced a price cap on the cost of sending text messages when abroad and hasintroduced a maximum charge for receiving and making a phone call. At a time when both external and internaleconomies of scale were lowering the unit costs of domestic phone calls, international roaming charges remained highand the Commission decided there was an exploitation of monopoly power.The Commission has had to balance the desire for competition with the need to avoid over-regulation. Vodafone madea pre-emptive strike ahead of the likely regulation in roaming charges, by saying it would cut the cost of using othercompanies’ networks when abroad by at least 40 per cent; it has since announced an end to roaming charges.Under the new limits there is a single tariff covering all 27 EU member states - bringing the maximum charge for makinga call while abroad down to 37p per minute. Receiving calls now costs a maximum of 17p per minute. Sending a textmessage from another country inside the EU will cost no more than 10p. Data transfer prices have also fallen, with onemegabyte of data now costing 85p.Investigating collusive behaviourIn recent years the EU Competition Commission has been active in investigating allegations of price fixingand market sharing. Here are some recent examples to explore: Commission imposes € 8.9 million fine in banana cartel (October 2011) South Korean and Taiwan TV screen firms fined by EU for price cartel (December 2010) Euro800m fine for airline cargo cartel (November 2010) EU investigates Googles dominance in search (November 2010) EU fines bathroom cartel 622m Euros (June 2010) Chipmakers fined by EU for price-fixing (May 2010) EU cartel fine for plastics firms (November 2009)Legal Collusion – Horizontal CooperationNot all collusive behaviour is deemed to be illegal. Practices are not prohibited if the respective agreements"contribute to improving the production or distribution of goods or to promoting technical progress in amarket” - for example: Development of improved industry standards of production and safety which benefit the consumer– a good recent example is joint industry standards in Europe for mobile phone chargers Information sharing designed to give better information to consumers Research joint-ventures and know-how agreements which seek to promote innovative andinventive behaviour in a market. The EU has introduced a “R&D Block Exemption Regulation” for thisIn December 2010 the EU Competition Commission introduced new guidelines on the types of‘horizontal cooperation’ that is allowed under EU laws.
3416) EU Farm Policy and Reform“European Union farm subsidies were paid out last year to Swedish accordion musicians, Danish snooker players, Dutchice skaters and an Estonian society for old school classmates, official figures show.” (Source: www.farmsubsidy.org)In this section we review the arguments surrounding the farm policies of the European Union.• The CAP is a complex system of farm support and has been a highly contentious issue for many years• Some believe that it has been one of the EU’s most successful policieso Farm payments give farmers security, predictability and a planning period to encourageinvestment. Many farms would simply not be viable without some form of subsidyo Subsidies are needed as a transfer of income to relatively low-income regions. Averageincome in farming is substantially lower than that in the rest of most EU countries• Others regard the CAP as a waste of money with huge economic, social and environmental costs• The CAP accounts for nearly half the EU budget – it cost 58bn Euros (£51bn) last year - 47% of thewhole EU budget - and it is the world’s most generous system of agriculture subsidies• The CAP is the biggest budget item - 47% of total in 2010 – average subsidy per farm: 12,200 Euros.If the pound falls against the Euro, this increases the value to British farmers of CAP payments.• 20% of CAP funds go to France; the UK gets 9% of total EU farm support. France, Spain, Germany andItaly together get 60% of EU farm subsidy money• New EU member states such as Poland and Latvia began receiving CAP subsidies in 2004, but at only25% of the rate they are paid to the older member states. These countries are lobbying for furtherreforms of the CAP to make it fairer to relatively poorer countries• There have been many attempts at reform over the years - reforming the CAP is crucial andcontroversial in terms of EU’s trading relationships with many developing countries
35Criticisms of the EU System of Farm Support(1) Production inefficiency and surplus: In the early years of the CAP, generous intervention pricesled to huge surpluses and a misallocation of scarce resources damaging consumer welfare.(2) An absence of innovation in farming: Some economists argue that direct payments to farmersact as a brake on innovation. Innovative marketing and product development in sectors de-coupled from direct price support such as pigs, poultry, potatoes and most fruits and vegetableshas been at higher levels than in more heavily-supported products(3) Industrial farming: The CAP has encouraged big business ‘factory farming’ or ‘industrial farming’has led to problems with food safety and animal welfare and has contributed to deforestationwithin Europe and increasing reliance on imports of cheap soya(4) Opportunity cost: Farm subsidies could have been better spent elsewhere e.g. on healthcare,transport infrastructure or investment in green energies(5) Fraud: For many years there have been accusations of corruption and fraud in the running of theCAP. Many subsidies go to farmers who are no longer producing – known as “sofa farmers”. Thecomplexity of the system of farm support has also made it expensive to operate(6) Environmental impact: There is plenty of evidence of long-term damage to the environment asfarmers searched for higher production yields in pursuit of farm subsidies.(7) Consumer welfare has been hit by higher food prices (trade diversion) leading to a sharplyregressive effect on lower income families where food is a higher % of total spending. Paying forthe CAP costs the average British family of four some £426 a year.(8) Impact on developing countries: The CAP is alleged to have caused severe damage to the foodexport industries of many LDCs – e.g. the dumping of EU food surpluses in their markets helpedby EU export subsidies. Africa accounts for less of the total trade in the world today than it did in1990, mostly because of its inability to export produce due to subsidies to farmers in Europe(9) Inequitable distribution of subsidy payments: Many farm support programmes benefit larger scale wealthier farmers most. Europe’sbiggest landowners have reaped the highest CAP payments. The Duke of Westminster,for instance, received a reported £5.8m pounds over the 10 years to 2009. The CAP since the enlargement of the EU in 2004 offers inequitable payments tofarmers. According to a recent report, while Greek farmers reap an average of €560 perhectare, those in Latvia get less than €90. Polish farmers get less than €200 per hectare. The CAP system channels money into the highly mechanised industrial farms on themost productive land such as the Paris Basin and East Anglia and Lincolnshire. But manyUK farmers remain poor despite the CAP. The poorest 25% of farms have income of lessthan £20,000 a year, and a third of those failed to make a profit over the past threeyears, according to a 2010 report from the Commission for Rural Communities The biggest CAP beneficiaries in 2009 were large sugar companies!Put these criticisms together and the CAP is claimed to be a deep example of government failure leading toan inefficient and inequitable allocation of scarce resources and much higher prices for consumers. But thepolitical interests of farming businesses and agricultural lobbyists in many EU countries have prevented fullscale reform to what is a discredited system of farm support.
36Analysis: Intervention prices and food surplusesThis is one of the analysis diagrams that might be used to show the impact of a high market interventionprice on food supply.Setting a high common target price for certain foodstuffs benefits producers who have exploited economiesof scale and brought down the marginal and average cost of supplying food. This is shown in the diagrambelow. At a given intervention price, the producer surplus accruing to the small-scale farmer is area Awhereas the producer surplus flowing to the large scale farmer is area A + B + C.But higher prices come at a cost – to consumers. Paying prices, which are significantly above world prices,means a loss of consumer surplus among EU citizens.
37Attempts to Reform the CommonAgricultural PolicyFarmers lobbying against CAP reforms at ameeting of the EU Commission in Luxembourg in2009For decades politicians have struggledto reach agreement on reforming theCAP. The biggest stumbling-block arethe deep vested interests of countries(and their farmers) who benefit mostfrom the system of CAP support – mostnotably the French who are the largestbeneficiaries of the CAP system.Some of the major reforms in recent years are mentioned below:(1) Set-aside: Designed initially to reduce surpluses and protect the environment – payments weremade to farmers to leave their land fallow and not grow food. Environmentalists welcomed thisreform because it helped to protect biodiversity in rural areas. Set aside was temporarilysuspended during 2007-08 in the wake of super-high world food prices. The new reforms aim forEuropean farmers leaving 7% of their land fallow(2) Decoupling: A single farm payment independent from production means that farm incomes areno longer dependent on how much food is supplied. This has helped to cut food surpluses andreduced the amount of European food dumped on the markets of poorer developing countries.
38But there is evidence that the bulk of farm payments flow to larger land-owners many of whomno longer farm but who rent out their land to tenants who receive no farm support.(3) Reductions in guaranteed prices (e.g. a recent 36% cut in guaranteed price for sugar) and anend to intervention buffer-stock schemes for products such as butter(4) Caps on maximum farm payments – October 2011 reform announcements plan capping thetotal subsidy a large farm can receive at 300,000 Euros(5) Environmental husbandry payments: Farm income payments conditional on EU farmersmeeting agreed standards of environmental care, food safety & animal welfare (known as crosscompliance).(6) Reduction in payments to bigger farms (known as “modulation” and “digression”) to helptransfer funds to EU rural development programmes(7) Financial incentives to encourage farmers to switch towards organic farming(8) A gradual move to allow food prices to be set by global forces of supply and demand.Many countries subsidise their agricultural industries and few are prepared to allow free market forces tooperate as a way of setting prices and influencing production in farming markets. There is inherent pricevolatility in international food prices and despite CAP support many farmers leave the industry each yearbecause they cannot operate profitably. Some of this has nothing to do with the CAP – for example the sharpfall in milk production in the UK is blamed in part on the monopsony power of the supermarkets in drivingdown the prices that milk producers get.But there are potentially huge gains to be had from fundamental reform of the CAP and a reduction in farmsubsidies worldwide. The Organisation for Economic Co-operation and Development (OECD) has estimatedthat cutting agricultural tariffs and subsidies by 50% would add an extra $26bn to world income.Index of Prices 2000=100The Economist Commodity Price IndexCommodity Price Index Food Commodity Price Index All ItemsSource: Economist Commodity Price Index06 07 08 09 10 11100125150175200225250Index100125150175200225250Industrial MetalsAll CommoditiesIndex of Global Food Prices
3917) Environmental Issues and Policies in the EUThe European Commission is setting tougher limits on CO2 emissions to tackle climate change. This action bythe EC appears to signal a belief in making stronger use of the market mechanism and incentives toencourage industry to confront the costs of environmental damage. But EU regulations / laws are also havinga direct effect on both producers and consumers. And many EU countries are prepared to introduce a widerrange of environmental taxes to achieve their long term carbon reduction targets.Environment as a public good• Environmental assets are quasi-public goods that are not usually exchanged on markets. Thus noprice emerges to signal relative scarcity and change consumer and producer behaviour• The destruction of these endowments is inevitable and inexorable without effective intervention• The key question is which combination of interventions is most effective in meeting specificenvironmental challenges.Europe faces a huge environmental challenge:• Growing municipal and industrial waste• Contribution of EU countries to global warming / climate change• Protecting nature and minimising the loss of biodiversity• Rising congestion, noise and air pollution• Water shortages and water quality• Natural resource depletion – preventing the tragedy of the commonsEU Targets:• 20% cut in greenhouse gas emissions by 2020, compared with 1990 levels• 20% increase in use of renewable energy by 2020• 20% cut in energy consumption through improved efficiency by 2020Main Environmental Strategies1. “Making the polluter pay” taxes to change relative prices to change incentives2. Raft of EU directives / regulations on environmental issues including end of lifedirectives for durables such as cars, washing machines and televisionsi. Max C02 emissions per km for new carsii. Water quality and safety, minimum waste recycling targetsi. Promoting renewable energy sources3. Promoting investment in carbon capture and carbon neutralisation schemes4. Development of carbon trading in Europe as a market based mechanism5. Application of the precautionary principle i.e. the principle that action/interventionshould be taken to prevent harm to the environment before full evidence is available.6. A degree of fiscal harmonisation within Europe to achieve some environmental goals7. Improving the flow of information to consumers about the carbon impact of theirpurchases and use of different products
40Carbon Trading(1) The EU Emissions Trading Scheme (EUETS) was launched in January 2005 and is a market-basedmechanism to incentivise reduction of C02 emissions in a cost-effective and efficient manner.(2) The EU scheme operates through the allocation and trade of CO2 emissions allowances. Itcreates a market in the right to emit C02. One allowance represents one tonne of C02equivalent. Companies get most permits free now but many electricity generators in Europe willhave to pay for all these from 2013.(3) A cap is set on emissions – this creates the scarcity required for the market. At the end of eachyear businesses are required to ensure they have enough allowances to account for theirinstallation’s actual emissions. There are heavy fines for those without such permits.(4) The aim of carbon trading is to create a market in pollution permits and put a price on carbon.In this way, policy can help internalize environmental costs of firms’ production and encouragelower emissions to tackle climate change(5) In a cap and trade system, the number of available permits would gradually decline. As the priceof the permits rises, so the economics of investing in cleaner technologies will change. The hopeis that businesses will look for ways of reducing c02 emissions in the most efficient way possible.a. Assets: If a carbon emitting business can under-use its initial allowance by better energyefficiency, it can sell its surplus on the market.b. Liabilities: If a business is faced by high costs to reduce its emissions, it must buy extraallowancesSupply and demand analysis diagrams can be used when discussing carbon trading schemes. The idea is to gradually cutthe supply of permits so that the carbon price is sufficiently high to incentivise businesses to look for ways to cut theirtotal emissions in the most cost-efficient way.EU Carbon Trading Market in TheoryPermit Price (Euro per tonne of C02)Quantity of PermitsSupply2010Supply2012Demand2010Demand2012Price2010Price2012Cap2010Cap2012
41Weaknesses of the EU carbon-trading scheme“In 2008, (Phase II 2008-2012), the EU carbon price peaked at almost €30 per tonne CO2 (t/CO2) (£26/tCO2).Following the global financial crisis and subsequent economic recession, the price then fell below €10/tCO2(£9/tCO2) in the first quarter of 2009. Over the past 12 months, the carbon price has fluctuated between €12-16/tCO2 (£10-14/tCO2).” (Source: UK Treasury Report, December 2010)(1) The EU system has suffered from government failure because of the over-allocation of carbonquotas and national freedom to allocate carbon permits. Allowances were handed out for freerather than being auctioned off(2) In recent times (partly because of the European recession), the carbon price collapsed with theeffect of driving up the demand for coal fired energy! – A dirtier fuel! (This is another example ofthe law of unintended consequences)(3) When carbon prices are low and uncertain, there is less incentive for companies to stoppolluting and there are fears for the future of many clean-energy projects that necessarily havelong lead-times. Some economists have called for a minimum price to be applied to the carbonmarket. The new UK coalition government has committed itself to introduce a floor price forcarbon and is considering supporting this with additional carbon taxes.The volume of carbon permits traded has grown but prices have been low in both phases“Given the lead times involved between the decision to invest and the plant generating electricity (forexample, around 8 years for nuclear, around 2-3 years for offshore wind and 4-5 years for carbon captureand storage), there is a need to influence investment decisions being taken over the next few years.”(Source: Treasury Report, 2010)
42Carbon offsettingMost emissions trading schemes offer trade in carbon offsets, or carbon credits. This allows emitters to paysomeone else outside the scheme to cut their emissions instead. If it is cheaper to pay someone in China toplant a forest to absorb carbon dioxide, or a factory in India to install clean technology to cut its emissions ofgreenhouse gases, then doing so will generate carbon credits equal to one tonne of emissions saved. Thesecredits count towards the emitter’s target back home. The use of offsets is usually controlled because somebusinesses may choose to use this as a way of buying their way out of their carbon-reduction obligations.Other carbon trading schemes have been introduced outside of the European Union – here are brief details:1. New Zealand emissions trading scheme (launched July 2010): Covers: Forestry, electricity, industrialprocess emissions and transport. Waste to start in 2013 and agriculture to start 2015.2. Japan: Tokyo metropolitan trading scheme (launched April 2010): Covers: Around 1,400 topemitters. Tokyo city sets emissions limits for large factories. Bi-lateral offsets scheme promotesemissions reduction projects in developing countries. This is Asia’s first emissions trading scheme.3. Californian climate change law (Launch: Law passed in 2006; carbon trade to launch 2012): Covers:Economy-wide emissions, from power plants, manufacturing and, in 2015, transportation fuels.4. South Korea emissions trading scheme (Launch: Phase 1 runs from 2013-2015): Covers: About 470companies or operations that emit more than 25,000 tonnes of carbon dioxide annually and arecollectively responsible for 60 percent of the countrys emissions5. India: Perform, Achieve and Trade system (Launch: April, 2011 with trading from 2014: Amandatory energy efficiency trading scheme covering more than 700 companies in nine sectorsresponsible for 65 percent of Indias industrial energy consumption.An alternative or a complement to trading: The economics of carbon taxationA carbon tax is a tax on the consumption or production of goods and services, which cause carbon emissionsThe case for a carbon tax:• A tax creates specific price on carbon – with less uncertainty than emissions-trading• It is a classic way of internalizing externalities (i.e. making the polluter pay) - the tax would raise themarginal cost of the cO2-emitting activities, up to the point that the marginal social cost ofabatement activities is equated to the marginal social benefit from these activities• Provides an incentive for firms to lower emissions and for consumer behaviour to change• The tax can be phased in and can be revenue neutral (i.e. other taxes can be cut)• Revenue generated can be “ring-fenced” and then recycled – i.e. spent on environmental initiativesCounter arguments:• Issues of who to tax and how much to tax when emissions are difficult to measure / quantify• Potentially high costs of compliance (administration) and the risk of tax evasion• Possible regressive effects on low-income families (when carbon taxes are passed on in prices)• Less certainty about the effect on quantity of emissions than a trading scheme• Non EU-countries may free ride i.e. enjoy a reduction in emissions without imposing their own tax• Would potentially damage competitiveness and jobs of EU countries• Would politicians be prepared to raise the carbon tax sufficiently high to reduce emissions?