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The Roots of the Single Market

The European Union, which began as the European Economic Community in 1958, was based on the new idea of a ‘common market’. Strictly, the Rome treaty did not define what the ‘common market’ was. However, most analysts at the time saw it as the combination of five ‘economic freedoms’ (four instances of ‘free movement’ (namely, for goods, services, capital and ‘persons’, probably including workers) and the right (of companies or individuals) to establish in any other EEC country, various forms of common policy-making (trade, competition, agriculture and transport) indispensable for a common market, common regulation, officially called ‘harmonisation’, and some coordination or lighter cooperation. All these aspects were specified to some degree in the Rome treaty. Later, with the first revision of the treaty in 1985, the notion of the ‘internal market’ was introduced in the text. The proposed treaty revision coincided with the famous EC1992 programme of 7½ years aiming for the ‘completion of the internal market’ (from mid-1985 to late 1992). The term ‘completion’ as well as the sheer ambition of the EC1992 programme quickly led many people to speak colloquially about the EU ‘Single Market’ ever since. The treaty has been revised four times since 1985, yet the term ‘Single Market’ is nowhere to be found. The present contribution will focus on the concept and treaty design of the Single EU Market, and will subsequently show how the EU internal market developed over time.

What Is a Single Market?

More Than the Law of One Price

The benchmark of a single market, which is suggested to every student of economics, is the law of one price. This textbook idea is a useful and simple summary indicator of the result that market integration will yield. Taking it literally would be misleading: even a local market in a small village does not exhibit complete price equality and whether price differentiation is a function of product differentiation on that local market is not easy to verify for consumers, and certainly not for incidental visitors without repeat purchases. Nevertheless, the benchmark is useful because it is expected that, in a single market, price divergences are held in check by actual and potential competition in that market and spatial competition from nearby markets in other locations. The assumptions behind such price convergence include good and timely information and actual and potential mobility of suppliers as well as consumers. Nevertheless, it reflects a very narrow perspective of market integration and its utility is more questionable in markets other than goods, such as all areas of services, in goods and services of network industries, in labour markets across countries and in knowledge markets (regulated or not by intellectual property rights). Nevertheless, there is much more to a Single Market than a tendency towards price convergence. A Single Market is also about (quality and other) differentiation in goods, services, capital and labour – hence, the gains of variety – and about the stimulus to come up with innovative ways of engaging in competition, be it via goods or services or process innovation, or in distribution or marketing. Companies long used to being a major player might be challenged by different ‘business models’ more appealing to the same or new consumers or customers. In some sectors, initial national prices may be a bad predictor of later prices in the Single Market due to scale economies (perhaps even amplified by ‘learning curves’) which can only be reaped with much larger volumes of turnover (see Pelkmans (2011) for a brief survey of the economic impact of the EU Single Market). For all these reasons, price convergence is a helpful but insufficient indicator of market integration for economists. For a proper economic understanding of a single market, one should appreciate the driving forces behind the eventual economic gains of a Single Market: competition in static and dynamic forms driving not only price convergence but also cost minimization and greater variety in goods and services, innovation and choice.

There is also the crucial issue of single market design. Does price convergence and a rich view of competition answer the query ‘what’ an internal market is? In fact, it does not; it merely tells economists whether a prominent economic test of the ‘working’ of that market is satisfied. If European integration has taught one lesson, it is that the building of such a Single Market is an extremely complex, highly intrusive and staggered undertaking. And this matters a lot for the economic study of the Single Market. The large ‘distance’ between one basic economic criterion to assess a Single Market and the many stages of its complex development has inevitably generated a literature which mainly focuses on general and ‘aggregated’ outcomes. Typically, it fails to give much economic guidance on the what and how of (deep) market integration.

Therefore, when going from the general concept of the internal market to a practical design which can be used for a treaty, the question of what a Single Market is usually answered by a ‘stages theory of economic integration’. What does it take, in terms of measures of the EU and market institutions, to get a well-performing Single Market? The traditional institutional approach was initiated by Balassa (1961) and was much refined and adapted later in the light of the EU experience (see Pelkmans 1982, 1985; see also Lloyd 2005). The five Balassa stages are: free trade area, customs union, common market, economic union and total economic integration. Whereas the first two were taken from GATT, art. 24, the other three are new concepts. With the latter three, there are serious problems of design logic.

Single Market: Stages Beyond a Customs Union

The ‘common market’ – beyond the free circulation of goods in the customs union with common tariffs – is defined by Balassa as the free movement of factors of production (capital, labour, and nowadays also codified knowledge, as in patents etc.). His common market has no institutional features other than a legal duty to liberalise cross-border flows of these factors. Clearly, this is a fantasy world: cross-border free movement of factors would at the very least assume common regulation for labour (not to speak of the profound implications for the welfare states) and for codified technology or knowledge but almost certainly it would also require common institutions enabling more detailed decision-making (especially for harmonisation and EU regulation). In the early 1960s most European countries still had fixed exchange rates and exchange controls; hence cross-border freedoms in capital movements would have had major macro-economic implications. In other words, ‘negative’ market integration (only removal of barriers) in a common market is unthinkable without ambitious ‘positive integration’ (common regulation, or lighter harmonisation, plus coordination and some common decision-making in common institutions) (see also Tinbergen 1954). If countries are wary of this degree of centralisation or commonness, positive integration will be insufficient, and without it ‘negative’ integration in factor markets will become impossible: it will simply not happen. Another gap in Balassa’s third stage is the neglect of services. Again, since many services are regulated and several are tightly supervised, a single market for services cannot come about without common regulation (overcoming market failures, ideally) and some central or coordinating supervisory agencies. As services cover a huge set of economic activities, the scope of centralization would increase considerably. But even in goods, a common market is far more than just free circulation behind common tariff walls. Nowadays, it is well understood that there is a broad range of other barriers or trade cost-raising elements in goods markets which have to be addressed if there is to be any chance of obtaining a ‘single’ market. But this simple fact changes radically the nature and ambition of that single market. The EU led the way in addressing such barriers, after having dealt with the customs union aspects without any remaining exceptions in less than the required 12 years. But the various ‘non-tariff barriers’ appeared to be much more difficult to tackle and eventually prompted innovative ways to overcome the frustrating stalemates in Council. At the same time, this process also led to degrees of regulation (and co-regulation, for example in overcoming technical barriers) and selective centralisation which had not been expected by the founding fathers.

The fourth stage of Balassa is called ‘economic union’. In Pelkmans (1991), a literature survey since the late 1940s shows that economists have not been disciplined in utilizing a single definition: no fewer than seven definitions, with very different meanings, can be found. Balassa’s definition brings in the common institutions and ‘positive integration’ only at this stage (rather than already for the common market), yet remains vague about what exactly the economic purpose and scope of this ‘union’ should be. If indeed the disparities in national policies would lead to discrimination (of market players or their goods, services etc.), it would have to be dealt with at the common market stage. As we shall see later, this kind of ‘economic union’ cannot serve an eventual monetary union either. This simple point underscores that the treaty design of deeper economic integration ought not to be taken lightly by economists.

The fifth Balassa stage is called ‘total economic integration’. It has two key elements: the ‘unification of monetary, fiscal, social and countercyclical policies’ and the ‘setting up of a supranational authority where decisions are binding for the Member States’. The latter element is several stages ‘too late’ since substantial positive integration will be required already for genuinely free movement of goods (beyond free circulation in the customs union), and the more so for services, labour, capital and codified technology in the common market. The former element (unification) is not only a huge jump from a vague ‘economic union’ but there is no obvious justification for so much centralisation. A ‘subsidiarity test’ (Pelkmans 2005) boils down to a cost–benefit analysis of (de)centralisation of public economic functions such as monetary, fiscal and social policies given an already realised single market. With centralisation criteria like scale and cross-border externalities, besides decentralisation criteria such as diversity of preferences among regions or countries and the (ceteris paribus) greater ability of local politicians to ‘read’ such preferences and act accordingly at the local level, a subsidiarity test will yield a much more nuanced view than Balassa’s fifth stage. It would show that social policy is highly unlikely to be a candidate for centralisation, and fiscal policy is suitable only in some respects (e.g. debt caps, but no or only modest union taxes). For present purposes, one can also ask the fundamental design question of whether a ‘deep’ single market can perform well over time without monetary union or without at least a credible mechanism for maintaining stable exchange rates.

Altogether, a Single Market is a highly ambitious ‘means’ for the pursuit of higher economic (and possibly non-economic) aims.

The EU’s Single Market Design in the Treaty

Today, the relevant treaty for the EU Single Market is the Treaty on the Functioning of the EU (TFEU), in force since 2010. It is one of the two Lisbon treaties (the other is the EU treaty). The basic idea of the internal or common market (the treaties have never used the term ‘Single Market’) has not changed much over time. What has happened is that both decision-making and ‘deepening’ have been facilitated several times. This has turned out to be critical. Figure 1 stylizes the EU internal market idea found in TFEU and case-law of the EU Court (CJEU). Figure 1 expresses the notion that the internal market is a ‘means’ – indeed, the principal means – for the pursuit of EU treaty objectives. Ever since the Rome treaty, these objectives prominently feature economic growth (in various formulations and under conditions, e.g. sustainability). Recurrent treaty revisions have overloaded the EU with new objectives, but how crucial these are and what priority they have is unclear. In any event, every time the Single Market moves (back) to the top of the EU’s agenda, the main motivation was and remains economic growth and/or productivity hikes. Figure 1 has a symmetric set-up: on the left side one finds ‘negative market integration’ (customs union, the four free movements and the right of establishment) and on the right hand side ‘positive integration’ consisting of the most important common policies as well as two prominent forms of ‘approximation’ or harmonisation (risk regulation, comprising a very large part of EU regulation and related to health, safety, environment, consumer and saver/investor protection; indirect tax regulation on e.g. VAT). In addition, Fig. 1 depicts ‘mutual recognition’ hanging in between the two.

European Union Single Market: Design and Development, Fig. 1
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EU internal market in the treaties

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Of course, with initial veto-based decision-making and the greatest hesitation on the part of the EU Member States to radically pursue cross-border intra-EU liberalization in goods, services, labour, capital and codified technology, as well as to apply free establishment to all sectors, or to engage in far-reaching and often intrusive risk regulation in many areas and submarkets as a condition of free movement, one can understand that the institutional state of EU market integration has only gradually moved towards the ideal picture of Fig. 1 over a period of five decades. This also goes for the common policies: initially, when a common agricultural policy (as the basis for an internal market in agro-goods) was created, there was no equivalent in fisheries; the common transport policy in the six modes only came about in earnest during the second half of the 1980s; EU competition policy operated almost 30 years without merger control, which is now the most important aspect; and EU trade policy in goods was only complete once third-country quotas at the national level had been outlawed (in 1992), whilst in services and investment full EU-level power was only granted in the Lisbon treaty. All such difficulties are good illustrations of why a proper understanding of the EU Single Market and its actual or potential economic impact is so demanding. Indeed, while Fig. 1 serves as a guide for the overall concept, a proper understanding necessitates the zooming in on some of the more important details and how these EU accomplishments have accumulated over time.

Deepening, Widening and Enlargement of the EU Single Market Over Time

Given the incredibly broad range of negative and positive integration the Single Market entails, we shall stylise the progressive accomplishments of the Single Market in four steps: one on the state of achievements after 25 years of EEC; one on the EC1992 programme; one on the accomplishments between 1993 and 2010; and one on the 2011 Single Market Act. It provides powerful and concrete evidence of the rising ambition of the EU’s Single Market. The increasing importance of the Single Market is the result of ‘deepening’ (firmer application of existing commitments, with fewer exceptions), ‘widening’ (of scope, that is, more domains are brought under the internal market) and ‘enlargement’ (more EU countries, hence a larger market size).

The EEC Common Market After 25 Years

Table 1 reflects what the EEC’s ‘common market’ looked like in 1982. It is best described as a ‘customs-union-plus’. The main items in the first word column are taken from Fig. 1. The table largely speaks for itself. The drafters of the EEC treaty and subsequently the Member States (and to a lesser extent, even the Commission) simply had no well-informed idea of what a common market, as specified in the Rome treaty, really requires.

European Union Single Market: Design and Development, Table 1 EU common market after 25 years
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Deepening and Widening Under EC-1992

Table 1 allows one to appreciate how radical EC1992 was. The striking difference between Table 1 and Fig. 2 (see above) is that measures and new accomplishments are observed in all five areas of free movement. Besides a range of initiatives in goods markets, two big services sectors (transport and financial services) are tackled and exchange restrictions are abolished. In addition, some horizontal aspects were improved, such as merger control, the gradual inclusion of network industries and more emphasis on mutual recognition. The list for goods markets is impressive: the very detailed customs code is realised, inner frontiers and physical customs are abolished, a huge number of highly technical directives and regulations in risk regulation are adopted (Old and New Approach etc.) including conformity assessment (Global Approach); in addition, food law is remodelled based on mutual recognition, extensive SPS-type harmonisation in no less than 160 directives and the avoidance of food-specific directives (but horizontal food directives instead, with far lower costs while maintaining the great variety that national traditions cherish); finally, public procurement was addressed so as to become competitive and open EU-wide. This is no longer a customs-union-plus: it implies far-reaching free movement in goods and selectively in some important services, such as several modes of transport as well as free movement in and EU regulation of financial services. It also comprises free movement in (financial) capital (albeit that equity in stock exchanges is still subject to problems of clearing and settlement) and at least some minimum rules (e.g. in occupational health and safety) in labour markets. It does not yet add up to a common market, since services are only selectively addressed, network industries still have to be brought in and IPRs have not yet been resolved, for example. Moreover, the regulation and cross-border liberalisation of financial services (banking, insurance and investment services) was incomplete, with serious gaps and omissions due to the reticence of Member States, whilst supervision was kept at national level, based on fairly general EU regulatory principles.

European Union Single Market: Design and Development, Fig. 2
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What EC-1992 accomplished

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Incremental Deepening After 1992

Some further progress as well as refinement of the internal market acquis has been accomplished since 1992. It is summarized in Fig. 3.

European Union Single Market: Design and Development, Fig. 3
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Deepening and widening the EU internal market: 1993–2010

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The main elements of deepening consist in IPRs at EU level (except the EU patent) and a major assault on barriers in services markets, in a number of ways. The horizontal services directive marks a U-turn in that all services markets should benefit from free movement, unless already regulated by EU rules (or exempted in a few instances). The other significant progress is liberalisation in six network industries (telecoms, electricity, gas, rail, air and postal). Also, a third generation of financial services regulation was built up, after the rules for establishment of financial institutions in the 1970s and those for free movement and mutual recognition of national supervision during the EC1992 process. The third generation (2000–2006) made EU financial services regulation more complete and technically more refined, in particular for investment services. However, it was insufficiently realised that the quality of EU regulation suffered from the undue emphasis of ‘light touch’ by the London City and the eagerness of many banks and others to exploit financial innovation. The EU regime did not guarantee that market failures were fully overcome and delivered insufficient guarantees for the proper assessment, management and pricing of risks in financial markets, especially at the wholesale level. In the event of major mistakes by large financial players, supervised or not, bank failures would become a real possibility, in extreme cases leading to contagion and systemic risks, hence endangering EU financial stability. Contagion was no longer a theoretical possibility, since the interconnectedness of banks in the deepened EU financial markets was increasing very rapidly. Furthermore, although national supervisors became embedded in EU supervisory networks, the latter remained cooperative and had neither the authority to act directly at EU level nor precautionary plans and/or funds to address cross-border contagion and systemic risks. Actual market integration began to run much too far ahead of the EU regulatory regime.

Once the financial crisis broke out in the autumn of 2008, the EU changed course: a fourth generation of EU financial regulation has been built up under duress (2008–2011). One may characterise this fourth generation by three key words: ‘better quality’ of regulation in overcoming market failures (e.g. in banking) by means of higher capital requirements or otherwise and doing away with ‘light touch’; regulating ‘all’ financial activities or actors, thereby including credit rating agencies, hedge and other investment funds and derivatives; and shifting to ‘more centralization’ in supervision, via EU Agencies, and in closely monitoring systemic risks and financial stability in a special EU Board. In addition, bank resolution rules have been tightened, with explicit shareholder risks and minimising risks for deposit holders, in combination with proposed EU funds which can immediately address cross-border bank failures if necessary.

In goods markets, the only widening of scope is in defence goods, where restrictions led to absurd practices and trade costs. All other initiatives amount to refinements, either by protecting better free movement and EU rules (e.g. the 2008 goods package), or by improving the benefit/cost ratio of existing EU regulation (e.g. REACH; a more flexible Old Approach) or by joint technical expertise in EU Agencies. Regulation related to climate strategies is new and rightly allocated (given cross-border externalities) at EU level. Mutual recognition of diplomas – a difficult issue even in federations – has been attended to, but this thorny question will require a much more thorough EU approach before it will effectively alter conduct in markets. Moreover, the benefit/cost ratio has also improved for EU competition policy (via modernisation) and for the quality of (proposed) EU regulation (via regulatory impact assessment = RIAs). Going by the list in Table 1, the EU has meanwhile shifted a lot closer to an advanced form of an internal market: how ‘single’ it is or not is crucial for the appreciation of further deepening and widening. One obvious gap is the lack of a European labour market, something a federation will enjoy but which would be possible in the EU, if and only if potential mobilities across intra-EU borders could be much larger. Only then would one be able to make an economic case for assigning labour market regulation and (at least part of) social transfers to the EU level. However, that unlikely outcome would, in turn, necessitate EU social charges or taxes, for which the treaty provides no legal basis. It is also possible to identify many ‘hidden’ obstacles, for a truly ‘single’ market to emerge in areas other than labour. This even includes a typical taboo so far in European integration, namely EU infrastructure. Certain network markets (electricity, gas, rail) cannot function properly on an EU scale without modern infrastructure designed with the single market in mind, not national or local priorities.

The Single Market Act

The fourth phase, initiated with the Single Market Act [COM (2011) 206 of 13 April 2011, Single Market Act] is yet another attempt to further deepen the internal market, in two steps, the first of which has been specified in some detail with 12 ‘levers’. The plan comprises initiatives to remove barriers – some of them deep-seated – as well as facilitation and cost-reducing measures which render the use of the Single Market more attractive. Given the high hurdles for smaller companies to actively participate in the internal market (see e.g. Mayer and Ottaviano 2007) these measures may well induce a higher degree of market integration. Amongst the measures removing obstacles, it is worth mentioning the EU common patent (and laws and a Court for common EU patent litigation) where the pure cost reduction of a patent would be as high as 80% and, perhaps even more importantly, the stimulus for innovation would be considerable (Guellec and van Pottelsberghe 2007) and permanent. Other measures proposed include greater investment in (mostly cross-border) energy and transport infrastructures, the removal of complicated obstacles to the Digital Single Market (often linked to private – e.g. contract – law and divergences in consumer protection, which typically tend to have remained largely national) and removal of (e.g. tax) barriers to a Europeanisation of venture capital. A full accomplishment of the Digital Single Market is expected to yield an increment to EU GDP of up to 4% (Copenhagen Economics 2010).

Conclusion

Altogether, the EU Single Market has steadily deepened and widened (in scope) over time. It has also become much larger, from 6 to 27 participating countries. Starting with a uniquely strong treaty, still one of a kind in the world, it has nevertheless taken some five decades, several critical treaty upgrades, and a host of programmes and special initiatives in order to arrive at a ‘deep’ but nonetheless incomplete Single Market. It has become an impressive edifice which, in some respects, is equivalent to internal markets in federal countries (Anderson 2011) and in other respects exhibits significant shortcomings. What is lacking in particular is a common labour market and the prospects for that are dim. Labour migration inside the EU will remain dominated by east–west flows (but only in a few professions, mostly low skilled) as long as wage divergences remain significant, and otherwise will continue to be ‘residual’. The other weak element – a common market for services – has been tackled recently with greater drive and intensity, but it would not be surprising to expect another one or more programmes to arrive at deeper services market integration in the coming decade or so. Nowadays, many services markets are still fragmented in the EU despite the 2006 horizontal services directive, and their contestability is often weak as well. Enforcement by the Commission, new business models in some submarkets and consolidation, as well as new entry, will inevitably take time. Also, services which fall outside this horizontal approach, such as network services, professional services and retail finance (mortgages or consumer credit for example), and also employment agencies and freight rail, are still encountering numerous problems when Europeanising their business strategies. Financial wholesale markets are rather well integrated. The remaining problems of the fourth generation include queries about (insufficient?) centralisation of supervision and crisis management, besides a few lingering doubts about EU regulation (e.g. should risks of banks arising from large exposure to large private parties not be extended to public securities as well?). A final weak spot in the Single Market is public procurement, a giant market in the EU (some 16% of GDP), where recorded cross-border contracts remain disappointingly low, despite several revisions of directives and reduced red tape.

See Also