Chapter 1

History

The Economics of European

Integration, Seventh Edition
Early Post War Period, 1945-50: death, destruction
and upheaval
Europe has experienced horrifying wars and was in ruins after WWII:
• Millions of people died, enormous damage to infrastructure and
economic capacity
• Pictures show London in late 1940 (left) and Dresden in 1945 (right)

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 2
Early Post War Period, 1945-50: A climate for radical
change and the prime question
Prime concern: ‘How can Europe avoid another war?’
• What caused the war? - Three schools of thought, implying three
different solutions
• blame Germany → ‘Neuter’ Germany to avoid any future aggression;
• blame capitalism → adopt communism;
• blame nationalism → pursue European integration.
lives are strictly connected
you cannot survivie without each other

→ European integration ultimately prevailed, but this was far from clear
in the late 1940s. economics plays a role

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 3
Early Post War Period, 1945-50: The beginning
of the cold war - context for the valuation of the decision
• Wartime alliance among the US, UK and USSR rapidly unravelled.
• Germany was divided into the US, UK, French, and Soviet zones in 1945.
• Communism spread in Eastern Europa: in Estonia, Latvia, Lithunia
during the war, in Albania, East Germany and Romania in 1945, Bulgaria
in 1946, Poland in 1947, and Hungary and Czechoslovakia in 1948.
• America and Britain rejected the Soviet vision and this confrontation lead
to the ‘Cold War’. The division ruled European realities for a half century.
you need a strong enough country in the border of 2 ideas to prevent the push: Germany
• US suggests Marshall plan for economic recovery.
but we have to make sure the past wont happen again
• 1948: US, UK and France merged its zones, plans for a new nation – West
Germany – began to take shape.
• Moscow reacted by blocking land traffic to Berlin in June 1948, countered
by the airbridge known as the Berlin Airlift.
• The Federal Republic of Germany and the German Democratic
Republic were established in 1949.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 4
Early Post War Period, 1945-50: Marshall Plan

Marshall Plan (1948) in exchange of a well developed institution

• The USA offered financial assistance if countries agreed on a joint
programme for economic reconstruction.
• Marshall Plan aid amounted to $12 billion, with half of this going to the UK,
France and West Germany.
• The Organisation for European Economic Cooperation (OEEC)
administered this aid and prompted trade liberalization:
• The OEEC (which in 1961 became the OECD) started in 1948 with 13 western
members of today’s EU plus Norway, Iceland, Switzerland and Turkey.
• It advanced European integration, i.e. by removing quotas on intra-OEEC trade
and establishing the European Payments Union.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 5
Make Europe not war: ECSC, EEC and EFTA, 1951-60

• The German Question: The formation of West Germany was hoped to

help with an economic recovery of post-war Europe ...
• ... but need to embed Germany in a European supranational structure
• European Coal and Steel Community (ECSC, 1951): Belgium, France,
Germany, Italy, Netherlands, and Luxembourg (the ‘Six’) place their coal
and steel sectors under the control of a supranational authority
(Schuman Plan) because they need these
materials for the army -> under
give up a part of their sovereignty (the gov cannot decide to use their own
resources for a certain project) to receive money from the marshall plan
control to avoid the war
• Failed attempts to create the European Defence Community (EDC)
and the European Political Community (EPC)
• European Economic Community (EEC, 1957): riding on the success of
the ECSC, the ‘Six’ committed to form a customs union, promise free
labour mobility, capital market integration, free trade in services, and a
range of common policies
• EEC meant discrimination against non-EEC Europeans, including OEEC
members like Britain having a custom community means discrimination

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 6
Make Europe not war: ECSC, EEC and EFTA, 1951-60
• European Free Trade Association (EFTA, 1960): tariff reduction
without harmonizing external tariffs – a free trade area (FTA) as
opposed to EEC, a customs union (CU) the six and the rest -> the another group
(EFTA 7) in response to the six (EEC6)

• Two non-overlapping circles by the late 1960s:

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 7
 Make Europe not war: ECSC, EEC and EFTA, 1951-60
The Federalism vs intergovernmentalism schism
• EEC vs. EFTA - two concepts about the depth of European integration
• Intergovernmentalism: nations retain all sovereignty, (economic)
cooperation only when necessary and agreed upon EFTA 7
• OEEC and EFTA, but also the Council of Europe (1949) and the Court of
Human Rights (1950), unrelated to the European Union
• Federalism: embed nations in a supranational structure (EEC, EDC,
EPC), embodied with some of the powers that had traditionally been
exercised exclusively by nations the losers want this
it’s better for others to decide
the six -> grow much faster

European integration gains economic motivations key: the population in the six is bigger ->
more attractive

• New view: (trade) liberalization is pro-growth , pro-industrialization

• Confirmed by spectacular growth in manufacturing, exports and
incomes, beginning in the 1950s („Wirtschaftswunder“, „Les Trente
Glorieuses“)

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 8
Evolution to two concentric circles
• While the first years of European Integration had a lot to do with geo-
strategic thinking after WWII, this changed with the formation of EEC
and EFTA.
• Falling trade barriers within the EEC and within EFTA (but not
between) led to discrimination.
• The GDP (i.e., potential market size) of the EEC was much larger than
that of EFTA (and EEC incomes were growing twice as fast).
• Thus, the EEC club was far more attractive to exporters and this led to
new political pressure for EFTA nations to join the EEC.
• The UK applied for membership in 1961 and Denmark, Ireland, and
Norway also followed.
• Charles De Gaulle stopped UK membership twice. Denmark, Ireland,
and the UK joined in 1973 while Norwegians said no in a referendum.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 9
Evolution to two concentric circles: First enlargement,
EEC–EFTA FTAs and the domino effect I
• Firms based in the remaining EFTA states would suffer a disadvantage
• EFTA industries pushed their governments to address this situation;
• Resulted in a set of bilateral free trade agreements (FTAs) between
each remaining EFTA nation and the EEC.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 10
Delayed trade integration, accelerated monetary
integration: the 1970s
Euro-pessimism 1.0: the 1970s
• Political shocks:
• ‘Luxembourg Compromise’ + enlargement = decision-making jam;
• unanimity was the typical rule in EEC decision-making procedures: the
insistence on consensus radically reduced the EEC’s ability to make decisions.
• Economic shocks:
• Bretton Woods falls apart, 1971-1973; EEC failed to establish monetary union
(Werner Plan was put on hold);
• 1973 and 1979 oil price shocks with stagflation;
technical standard in each country (the shape
• New trade frictions: ‘technical barriers to trade’ of bottle water -> more cost to adapt)
we grew so much in the 60s, now we can start protectionism
• However, also some bright spots:
• democracy in Spain, Portugal and Greece lead to their accession;
• EMS set up in 1978 works well. Special role for the Bundesbank.
• Budget Treaties (1970 and 1975) and direct election of EU Parliament (1979).

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 11
Deeper circles and the domino effect part II: the
Single Market Programme
The Single European Market (SMP) was a powerful boost to European
economic integration:
• Jacques Delors launched completion of the internal market;
• The Single European Act (SEA, 1987) aimed to create ‘an area without
internal frontiers in which the free movement of goods, persons,
services, and capital is ensured’ (i.e., the four freedoms already
promised by the Treaty of Rome);
• It also implemented important institutional changes: EEC was
renamed the European Community (EC) and European Union (EU)
after monetary union was agreed upon in the 1990s
• majority voting instead on unanimity on issues related to the Single
European Market;
• This change in voting procedures unleashed a massive wave of TBT
liberalization and gave a big boost to further trade integration;

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 12
Deeper circles and the domino effect part II:
the Single Market Programme

Basic elements of the Single Market Programme (SMP):

• Goods trade liberalization
• streamlining or elimination of border formalities;
• harmonization of VAT rates within wide bands;
• liberalization of government procurement;
• harmonization and mutual recognition of technical standards in production,
packaging, and marketing.
• Factor trade liberalization
• removal of all capital controls (which ultimately led to the euro);
• liberalization of cross-border market-entry policies, including mutual
recognition of approval by national regulatory agencies. = enlarging the market

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 13
Deeper circles and the domino effect part II: the Single
Market Programme
Dominos again: the EEA and the fourth enlargement
• ‘Investment diversion’ effect (on top ‘trade diversion’ effect already by
customs union).
• Non-EU governments under pressure to react.
• The fourth enlargement (1995) adds Austria, Finland, Sweden, and leads
to the EC15.
• Norway, Iceland and Liechtenstein: European Economic Area (EEA,
1989). Accept single market regulations in return for market access, retain
sovereignty over non-Single Market issues („Norway Option“). enjoy the condition but
no voice in deciding

• Swiss solution: complicated set of bilateral, EEA-like treaties with the EU.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 14
 Reuniting East and West Europe

Communism’s creeping failure and spectacular collapse

• Division of Europe was cemented by the Berlin Wall (1961).
• By the 1980s, West’s economic system provided a far better way of life
and living standards diverged.
• Up to 1980s, Soviets thwarted reform efforts but inadequacy of Soviet
system forced changes in USSR, i.e. pro-market reforms (perestroika)
and openness (glasnost).
• Pro-democracy forces in the central and eastern European countries
(CEECs) had been repeatedly put down by military force hereto but
found little resistance from Moscow in the late 1980s:
• June 1989: Polish labour movement ‘Solidarity’ forced free
parliamentary elections and communists lost. Moscow accepted new
Polish government.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 15
Reuniting East and West Europe

• Moscow’s hands-off approach to the Polish election triggered a chain of

events:
• Hungary opened its border with Austria and many East Germans
moved to West Germany via Hungary and Austria;
• mass protests in East Germany; Berlin Wall falls 9th November 1989;
• end of 1989: democracy in Poland, Hungary, Czechoslovakia;
• end of 1990: German re-unification.
• End of 1990: independence of Estonia, Latvia, and Lithuania.
• End of 1991, the USSR itself breaks up.
• Former Soviet Republics becoming independent nations or merging
with Russia. the balkans: do we make them wait or we include them?
if make them wait, russia will take over -> history repeats

• The Cold War ended without a shot and with it, the military division of
Europe ends.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 16
Reuniting East and West Europe

First steps: the Europe Agreements

• CEEC announced that their goal was to join the EU
• At first, no promise of eventual membership was made.
• but ‘Europe Agreements’ were introduced: free trade agreements with
promises of deeper integration and some aid.
• In 1993, the EU sets the Copenhagen criteria for accession of CEECs:
• political stability of institutions that guarantee democracy, the rule of law,
human rights, and respect for and protection of minorities; iaam protected by the law
guarantee for you that
you can live your life
• a functioning market economy capable of dealing with the competitive
pressure and market forces within the Union;
• acceptance of the Community ‘acquis’ (EU law in its entirety) and the ability to
take on the obligations of membership.
• Copenhagen summit (2002): CEEC nations plus Cyprus and Malta join in
2004 (5th enlargement). a gap in the rule making procedure: what happen if someone
behave badly in the UN? Hungary case - only solution now:
cutting budget >< not effective

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 17
Reuniting East and West Europe

Preparing the EU for eastern enlargement

• Envisaged enlargement required EU to reform its institutions (designed
for six members initially).
• New CEEC-members: Poorer, more agrarian, small populations per
member state but in total 300 million more people. poor ppl from poor country -> problem
• The process was politically painful for the existing EU members since
almost every change helped some EU15 nations but hurt others.
• Basic dilemma: while there was a shared understanding of the
institutional challenges, there was little agreement on the solutions.
• Four attempts at reform over a 16-year period:
• Amsterdam Treaty, 1997;
• Nice treaty, 2000;
• (rejected) Constitutional Treaty, 2004;
• Lisbon Treaty, 2007.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 18
Monetary Union
can be a problem due to the history

German unification and renewed push for integration

• Political consensus: accompany German unification with increased
European integration.
• Delors proposes 2nd radical increase in European economic
integration: monetary union.
• Maastricht Treaty (‘Treaty on European Union’) signed 1992:
monetary union by 1999, a single currency to put into circulation by
2002.
• Further elements:
• EU citizenship;
• strengthened EU cooperation in non-economic areas (justice, defense
etc.);
• strengthened the power of the European Parliament;
• introduced the ‘Social Chapter’.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 19
Monetary Union

From ratification difficulties to the introduction of the euro

• Ratification difficulties:
• Britain opted out of common currency;
• Danish voters rejected the Treaty and reversed their choice only once
Denmark opted out of common currency.
• Maastricht convergence criteria as entry conditions to enter the monetary
union.
• 4 January 1999: freezing of the exchange rates of 11 countries
• Establishment of the European System of Central Banks (ESCB) and
the European Central Bank (ECB).
• January 2002: euro banknotes and coins.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 20
Global and Eurozone crises and institutional responses
if a country fails -> othesr also fail -> require reforms

• European economic integration during the 1990s and much of the 2000s:
Great moderation: growth, low and stable inflation.
• 15 September 2008 Lehman Brothers, a major US bank, became
insolvent, and the US authorities decided to not bail it out.
• Reconsideration of risk associated with lending to weaker nations in
financial markets: interest rates started to diverge between nations like
Greece and Germany.
• Eurozone Crises unfolds: Irish bail out of the Anglo Irish Bank in January
2009, anouncement of higher than thought government debt in Greece in
October 2009.
• Financial markets: fears about nations solvency and the surivival of the
euro zone.
• Several emergency loans and rescue packages by other EU nations and
the International Monetary Fund (IMF) to stabilise Greece, Ireland,
Portugal and Spain; followed by a massive institutional reform.
McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition” 21
 Euroscepticism 2.0
• Rise of populists’ anti-EU positions, push for more national sovereignty
(more intergovernmentalism) from Marie Le Pen (France), Matteo Salvini
(Italy), Geert Wilders (Netherlands) and others.
• Eurosceptic vote shares in national and EU elections, 1992 to 2020:

• On the other hand: High and rising positive image of the EU by a majority of
EU citizens
• Probable explanations: Economically harsh conditions? Migration shock?

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition” 22
 Brexit the UK experienced a shock because they were not autonomous, they depended a lot on the UN
ppl with low power vote against to show their power (in poor regions in the UK)

• 23 June 2016: Should the United Kingdom remain a member of the

European Union, or leave the European Union?
Remain: 48% Leave: 52%
• Lack of a plan: how to leave the EU and about the future relationship
between an independent UK and the EU and the Single Market.
The long, difficult and messy Brexit negotiations
• Brexit began in 2015 by a political gamble by PM David Cameron, who
won the general election but failed to win the promised Brexit-referendum.
• Theresa May (a remainer) took over as PM, started a 2-year exit clock,
called for a general election and lost the conservative majority in
Parliament.
• Key problem in Brexit negotiations: Avoiding a hard border between
Northern Ireland and the Republic of Ireland, that is a member state of
the EU and part of the Single Market.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition” 23
 Brexit
• The three options for the Northern Ireland Protocol, none of them accepted
by the EU, the UK and Northern Ireland.

• After many failed attempts to find a fourth option, a general election in 2019
and after Boris Johnson became Prime Minister, extended deadlines - the UK
left the Single Market and EU Customs Union in January 2021.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition” 24
 COVID19 pandemic & European Green Deal
• The COVID19 pandemic cost (and continues to cost) many lives and
affected the health of many. The impact on economies worldwide were also
enormous.
• The measures taken to contain the pandemic, which consisted in the
beginning mainly of restricting physical contact, led to a recession and a
resurgence of national unilateralism (not only) in Europe.
• But co-operation within the EU also played an important role, e.g. in vaccine
procurement or through a recovery fund "NextGenerationEU", which for
the first time is fundeded by borrowing by the EU itself.

• European Green Deal: Spending plan 2021-2027 shifts EU priorities

toward climate change issues.
• Carbon neutrality by 2050 as a legally binding obligation, goal of 55
percent lower emissions in 2030.

McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition” 25