The European Union

The European Union, then known as the European Economic Community, was set up in 1958. The six member countries (West Germany, France, Italy, Belgium, the Netherlands and Luxembourg) committed themselves, in the Treaty of Rome, to establishing a Common Market. By the late 1990s the EU consisted of 15 countries. They included the original six plus countries such as the UK, Spain, Eire, Greece and Sweden. At that time other countries such as Slovenia, Hungary and Bulgaria were hoping to join in the future.

Four basic types of economic integration

1. Free trade area (FTA): Tariffs are abolished among FTA members (there are no internal tariffs) but each member retains its own external tariff against non FTA countries, eg. NAFTA, EFTA,

2. Customs union (CU): Members set a common policy for trade and tariff with non-members. The EEC was a customs union.

3. Common Market: Abolition of restriction on mobility of production factors such as labour and capital.

4. Complete economic integration: Fiscal and monetary policies are unified to create even greater economic harmonisation. This level implies a degree of political integration. This is the direction in which the EU is moving.

There are some advantages to businesses operating in countries belonging to a customs union or common market.

  • Firms operating within customs unions have free access to markets which would otherwise be protected by tariffs or quotas. In this way British firms, for example, have access to all other EU markets. For many firms this provides them with the opportunity to operate in EU markets in much the same way that they would at home.
  • Firms will have access to the most appropriate factors of production. A British firm might purchase cheap land in Southern Portugal for a new factory location, skilled designers from Italy or capital equipment from France.
  • Customs unions provide firms with large markets to sell to. The bigger the market a firm is selling to, the greater the economies of scale it is able to benefit from. The EU provides firms with access to 360 million consumers.
  • Businesses operating within a common market will be protected from competition from outside this area by an external business. Such protection allows businesses to be sheltered from the potentially damaging effects of competition such as price wars.
  • Increased competition from European firms may act as an incentive for British firms to increase efficiency and standards.

There are, however, disadvantages for businesses operating within a customs union or common market.

  • Before Britain joined the EU, British firms could buy goods and services from the lowest cost producers around the world. Foodstuffs were imported in huge quantities from New Zealand and the USA in this way. Since joining the EU, however, British firms have had to pay far more for foodstuffs from New Zealand and Australia because of the common external tariff.
  • Whilst a British based firm will have free access to other EU markets, businesses based in these markets will also have access to the UK market. Such competition may reduce the market share which domestic businesses have established.
  • Protection from external tariffs is not always beneficial to firms operating from within a common market. This is because being sheltered from external competition may result in less incentive for a firm to become more efficient. In the long run, this may lead to a deterioration in the firm’s performance.
  • Firms may have to adapt their marketing strategies to suit the needs of consumers in each country within the customs union. For example, surveys have found that of the thousands of products commonly sold in European supermarkets, only a small proportion are widely on sale in identical format in at least the four largest countries.

The four freedoms

Free movement of goods, services and capital: The first step in the creation of the internal market was to eliminate all the customs duties levied on imports and exports between the member states. In the EU goods, services move freely and at the same time common customs rules and rates are applied in relation to products and services coming from outside the area. Member states also succeeded in freeing all capital movements.

Free movement of persons: Nationals of countries who are signatories to the Schengen Convention may move freely across borders without passport or administrative requirements.

a, Geographical mobility is a person’s right to go and stay in another member state to seek employment.

b, Occupational mobility covers people’s right to pursue whatever occupation they wish.

c, Social integration refers to workers’ right to all the general welfare benefits available in the given member state

The Treaty of Maastricht

The Maastricht Treaty was approved in 1991. It calls for establishing the European Economic and Monetary Union (EMU) and also a political union. The EMU is designed to result in a common currency. In order to introduce a common currency, member states should bring their monetary and fiscal policies closer together so that inflation rates, budget deficits as a percentage of GDP and public debt as a percentage of GDP would be reasonably similar. The political union involves a number of issues, such as a common European citizenship, joint foreign, defence, immigration and policing policies and the harmonisation of social policy concerning working conditions and employees’ rights. Some countries, such as France and Germany want closer European integration, others such as the UK and Denmark want less centralised control.

EU policies and business

The European Union has economic policies which are designed to help businesses within member countries. These policies vary from employee protection and consumer protection  to transport and energy policies. Here we will concentrate on three policies and their effects on business.

The Common Agricultural Policy (CAP): This policy operates in all EU countries and accounted for approximately half of the EU’s 590 billion budget in 1998. Article 39 of the Treaty of Rome states 5 objectives of agricultural policy:

  • to increase the productivity of agriculture;
  • to ensure a fair standard of living for farmers;
  • to stabilise markets;
  • to guarantee supplies;
  • to ensure fair prices.

Farmers are guaranteed a fixed minimum price by the EU for their produce. The EU will buy up any amount that farmers produce at this price. Farmers could, of course, always sell on world markets if the market price was higher. If the market price drops below the minimum, however, CAP maintains the price to farmers, thus guaranteeing their income. For farmers the CAP guarantees them a price for their produce so that they are not at the mercy of fluctuations in price. This means that fewer farmers will go out of business during difficult years and, to some extent, their incomes will be guaranteed.

The CAP has a number of problems associated with it.

  • Overproduction: The setting of high, guaranteed prices has often caused excess supplies of a variety of agricultural products. Any excess supply is purchased by EU authorities. They prevent it from being sold on markets by storing it, resulting in butter mountains, wine lakes etc.
  • High prices: The minimum price set by the EU for agricultural products as part of CAP is very often higher than the price which would have resulted without their intervention. It is consumers and businesses such as food retailers who suffer as a result of these high prices.
  • Purchasing excess supplies of agricultural products is expensive for the EU. It is possible that the money spent on this could be better diverted to projects such as providing grants to firms engaged in producing new high technology products.
  • It prevents non-EU countries from competing in EU markets. It therefore represents an obstacle to the signing of  international trading treaties.

Regional policy

The Regional Fund: This provides funds to member states to help reduce unemployment in depressed parts of the EU. It also aims to encourage development in areas on the edge of the EU, such as Southern Italy and Northern Ireland. For example, construction firms may win contracts to build new roads, or industrial units could be financed through the Regional Fund. Similarly, firms may receive investment grants if they locate in particular parts of the EU.

Social policy

The Social Chapter: The Maastricht Treaty was signed by all EU member states in December 1992. One section of this treaty is the Social Chapter.  The aim of the Social Chapter is to standardise working conditions throughout the EU so that all workers within the community are guaranteed basic rights. These include the following:

  • A minimum wage to be paid to all workers.
  • A maximum working week.
  • A minimum paid holiday per year.
  • The freedom to join a union.
  • Access to appropriate training.
  • The right to be consulted and informed about company plans
  • The protection of young workers.

The UK initially opted out of the Social Chapter, when all other EU nations signed it. However, the UK signed up to the Social Chapter after the election of a Labour government in 1997. What might be the implications of the Social Chapter for businesses?

  • Workers may be better motivated. This should make them more effective and productive employees, able to raise the efficiency of the firm for which they work.
  • Industrial relations may improve as employees are involved in making company decisions and consulted about the work which they carry out.
  • It may raise the labour costs of those firms currently employing workers at wages below the minimum level set out in the Chapter. Those firms expecting their employees to work longer than maximum may also find their costs rise as they are required to employ more people.
  • Higher labour costs may make it more difficult for EU based firms to compete with businesses in low wage countries, such as China or South Korea.

The Single European Market

A major event in the EU’s move towards free trade was the signing of the Single European Act in 1986, which established a SINGLE EUROPEAN MARKET which came into being on 31 December 1992. Despite the existence of a customs union for over 30 years, there were still many non-tariff barriers to trade in the EU. This Act aimed to remove those barriers between EU member countries. The effects of this should be to encourage the freer movement of people, goods, services and capital. Three categories of barriers were removed.

  • Barriers which prevented entry into markets. For example, differing technical standards were required of products by different member states. This made it difficult for firms to enter certain markets. Also, the practice of public sector contracts being given only to domestic firms prevented free trade.
  • Barriers which caused firms’ costs to rise. Often complex documents were needed in order to move goods from one country to another. Also, there were long delays waiting to get exports through customs posts.
  • Barriers which lead to the market being distorted. Such barriers are said to prevent firms from competing on equal terms. They included differing rates of VAT in EU countries and subsidies given by EU governments to domestic industries.

Not all firms have been affected to the same degree by the Single Market. In some industries, very few barriers to trade existed between EU countries before December 1992. Firms operating in such industries have seen little or no changes to their situation. However, in other industries, where trade barriers were high, the Single Market has resulted in major changes for those firms operating within them. What effects has the Single Market had on firms in member countries?

  • Product standards. Firms have, for example, had to alter their products so that they meet new product standards. Many firms have had to improve the safety aspects of their products in order to meet new EU regulations.
  • Harmonisation of tariffs and taxes. There have been attempts to harmonise VAT rates throughout the EU. For businesses this may mean that the selling prices of their products rise or fall in line with VAT rate changes. In the UK, a number of products such as childrens’ clothes and books, which had previously not attracted any VAT, now have to face this tax as the UK seeks to fall into line with other EU countries. Attempts have also been made to harmonise EXCISE DUTIES on products such as petrol, tobacco and spirits. This has affected the price at which these products are sold and, therefore, the businesses marketing them.
  • Ease of trading. The reduction in the number of customs posts, and the amount of paperwork which is required for goods traded between EU countries, should save businesses time and reduce costs.

The single European currency EUROPEAN MONETARY UNION (EMU) became a reality

in January, 1999 when a single European currency was introduced. At that time, eleven of the fifteen member states of the EU signed up to the single European currency, known as the euro. Four member states of the EU, including the UK, delayed the decision to join the single currency in 1999. They indicated that they would decide whether or not to join at a later date.

In 1999 participating countries fixed their exchange rates so that they could not move against each other and against the euro. In 2002 euro notes and coins were to be available. In order to manage the single currency a European Central Bank (ECB), based in Frankfurt, was established. Amongst other things the European Central Bank is responsible for setting interest rates throughout the eleven participating countries.

It was argued that European Monetary Union would have a number of benefits for businesses within the euro zone:

  • A reduction in transactions costs: It is expensive for a business to change currencies when trading abroad. There are administration expenses in exchanging the currencies and possible charges. The costs of exchanging one currency for another are eliminated if all trading between countries is done in euros. For example, a French business exporting telecommunications equipment to Italy will no longer have to convert Italian lira into French francs. It has been estimated that the savings made from the introduction of the single European currency would be between 0.25 to 0.5 percent of national income for a member country.
  • A reduction in uncertainty: The uncertainties of trading are reduced for those businesses within the euro zone. It has been argued that greater stability within the euro zone would lead to greater confidence amongst businesses, thus leading to more trade between member countries. One reason for stability is because there is no possibility of exchange rate fluctuations. Fluctuations in exchange rates can make it difficult for importers and exporters to know what price they will receive or have to pay for future transactions. For example, a Spanish business that received the value of 500,000 lire instead of 600,000 for a sale as a result of a fall in the value of the pound will find that its profit margins are cut. Some businesses try to hedge against rising prices by stockpiling stocks of components, which can be expensive. It could also be argued that the control of monetary policy by the ECB would not lead to sudden, large changes in interest rates, for example. The control of interest rates to restrict inflation should also lead to more stable conditions in which businesses may operate. Businesses may also have a greater choice of finance if the euro encourages more investors in stock exchanges.
  • Transparent prices: pricing all products and services in one currency makes price differentials for products in different countries more obvious. This may show that a company is offering good value for money in the products it is selling. Companies that charge different prices in different countries may decide to reduce their prices to be more competitive, or to round up prices, which may increase profits. Companies will also be able to see the prices of competitors more easily.
  • Merger activity: The introduction of a single currency will make cross-border mergers between businesses in member countries easier. They will each have the same pricing and accounting system, which should help the coordination of the business.


The impact of the ECB: The European Central Bank’s central role in setting interest rates and controlling monetary policy for all nations within the euro zone could have a damaging effect upon businesses. This is because the interest rates and monetary policy pursued by the ECB will reflect the needs of the member countries as a whole. If there are inflationary pressures in the euro zone the ECB is likely to pursue tight monetary polices, such as the raising of interest rates. However, there may be particular countries within the euro zone which do not have inflationary pressures, but which are seeking to avoid recession. Such countries would also be subject to tight monetary policies, but for them it would be inappropriate. These policies could help drive these countries into recession with damaging effects for business.

EU institutions

The European Council is made up of the Heads of State or Heads of Government and the President of the European Commission assisted by the Foreign Ministers and a member of the Commission. It meets twice a year in the capital of the member country whose head of state or government is currently the President of the Council of Ministers. It does not make laws and it is not involved in “routine” decision making but it does make key political decisions on many of the most important, most sensitive, and most controversial matters facing the EU.

The Council of Ministers, based in Brussels, is the real power behind the bureaucracy. It is the main decision-making body. It is entrusted with deciding major policy issues for the EU.

The European Commission with its headquarters in Brussels, is the EU’s watchdog or “civil service”. Its commissioners are nominated by the governments of the EU countries for five-year renewable terms. The Commission has various duties, five of which are of particular importance:

  • Initiates EU policies.
  • Has major responsibilities with regard to the management, supervision and implementation of EU policies.
  • Together with the Court of Justice ensures that EU law is respected.
  • Represents the EU in many of its external relations.
  • Acts as a mediator and conciliator.
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The European Parliament is elected by direct universal suffrage. It normally sits in Strasbourg

where full plenary sessions, open to the press and public, are held for one week each month. The representatives are seated in Parliament by political party, not nationality. It functions as a political driving force and it is also a supervisory body with the power to approve the appointment of the European Commission and to dismiss it on a censure motion carried by a two-thirds majority.

The Court of Justice is the chief judicial body of the EU.