Chapter Review: Key Points 1 The Single European Act commits EC governments to completion of the single market by 1992. The framework is a common set of broad outlines for regulation, national implementation, and mutual recognition of firms licensed in other member-states.
For many countries this involves substantial deregulation. Together with enlarged market size, this should increase competition unless Euromergers go completely unchecked. The Cecchini Report estimates the total benefit in the range of 2.5—6 per cent of EC GDP. Some economists think the gain will be substantially larger.
3 The main winners will be the southern countries of the EC, who can exploit their relatively cheap labour and still have scope for scale economies. Northern competitors in these industries are likely to lose. More advanced industries in the north may do well if external economies of scale allow them to tackle the heavyweights in the US and Japan.
A monetary union means permanently fixed exchange controls, free capital movements, and a common monetary policy. These matter much more than whether or not we go the extra step to a common currency.
In abolishing capital controls for 1992, the EMS is already committed to almost complete harmonization of monetary policy. The UK became a full EMS member in 1990.
The Delors Report recommended progress to EMU in three stages. Stage 1 began on 1 July 1990 and envisaged exchange rate stability gradually increasing. All EC countries must be full EMS members before the end of Stage 1, and negotiations about the form of EMU will be completed during this phase. Realignments will be possible though discouraged. No date is set for the transition to Stage 2, when the new institutions will begin rehearsing their eventual role, though as yet without formal power. Realignments will be allowed only as a last resort. Stage 3 establishes the European Central Bank to run monetary policy. Exchange rates are fixed for ever. The EC has the power to put ceilings on national budget deficits.
7 In EMU, countries can change their competitiveness through the slow process of domestic wage and price adjustment. In the absence of any federal fiscal system, individual member-states are likely to want to retain control of fiscal policy as a last resort for dealing with crises.
To make Europe's tough monetary policy credible, it would be better to make the new central bank independent, and allow governments fiscal freedom provided they are prepared to borrow in bond markets to finance budget deficits.
Eastern Europe is embarking on economic reform. It begins with high foreign debt, but Western countries are offering aid and holidays on debt repayment. Tying assistance to continuing reform helps strengthen the hand of the reformers.
Supply-side reform means introducing the profit motive and deregulation, and allowing the price system to work. Because prices have been artificially low, initially there were sharp increases in prices. The challenge for policy is to stop this from turning into hyperinflation. Macroeconomic policy needs to be firm during this dangerous phase.
Trade and investment links will quickly develop between Eastern and Western Europe. Productivity growth in the East could be rapid. East Germany has the special advantage of reunification with West Germany. This is likely to keep East German inflation in check after a brief initial period.
The single market
Federal fiscal system
European Central Bank
European Bank for Reconstruction and
German Monetary Union MORE TERMS AND USEFUL VOCABULARY CAN BE FOUND IN THE TEXT ABOVE