The Gains from 1992
In 1987, the nations of the European Community (now known as the European Union) agreed on what formally was called the Single European Act, with the intention to create a truly unified European market. Because the act was supposed to go into effect within five years, the measures it embodied came to be known generally as “1992.”
The unusual thing about 1992 was that the European Community was already a customs union, that is, there were no tariffs or import quotas on intra-European trade. So, what was left to liberalize? The advocates of 1992 argued that there were still substantial barriers to international trade within Europe. Some of these barriers involved the costs of crossing borders; for example, the mere fact that trucks carrying goods between France and Germany had to stop for legal formalities often resulted in long waits that were costly in time and fuel. Similar costs were imposed on business travelers, who might fly from London to Paris in an hour, then spend another hour waiting to clear immigration and customs. Differences in regulations also had the effect of limiting the integration of markets. For example, because health regulations on food differed among the European nations, one could not simply fill a truck with British goods and take them to France, or vice versa.
Eliminating these subtle obstacles to trade was a very difficult political process. Suppose France decided to allow goods from Germany to enter the country without any checks. What would prevent the French people from being supplied with manufactured goods that did not meet French safety standards, foods that did not meet French health standards, or medicines that had not been approved by French doctors? Thus, the only way that countries can have truly open borders is if they are able to agree on common standards so that a good that meets French requirements is acceptable in Germany and vice versa. The main task of the 1992 negotiations was therefore one of harmonizing regulations in hundreds of areas, negotiations that were often acrimonious because of differences in national cultures.
The most emotional examples involved food. All advanced countries regulate things such as artificial coloring to ensure that consumers are not unknowingly fed chemicals that are carcinogens or otherwise harmful. The initially proposed regulations on artificial coloring would, however, have destroyed the appearance of several traditional British foods: Pink bangers (breakfast sausages) would have become white, golden kippers gray, and mushy peas a drab rather than a brilliant green. Continental consumers did not mind; indeed, they could not understand how the British could eat such things in the first place. But in Britain, the issue became tied up with fear over the loss of national identity, and loosening the proposed regulations became a top priority for the British government, which succeeded in getting the necessary exemptions. On the other hand, Germany was forced to accept imports of beer that do not meet its centuries-old purity laws and Italy to accept pasta made from—horrors!—the wrong kind of wheat.
But why engage in all this difficult negotiating? What were the potential gains from 1992? Attempts to estimate the direct gains have always suggested that they are fairly modest. Costs associated with crossing borders amount to no more than a few percent of the value of the goods shipped; removing these costs adds at best a fraction of a percent to the real income of Europe as a whole. Yet economists at the European Commission (the administrative arm of the European Union) argued that the true gains would be much larger.
Their reasoning relied to a large extent on the view that the unification of the European market would lead to greater competition among firms and to a more efficient scale of production. Much was made of the comparison with the United States, a country whose purchasing power and population are similar to those of the European Union, but that is a borderless, fully integrated market. Commission economists pointed out that in a number of industries, Europe seemed to have markets that were segmented: Instead of treating the whole continent as a single market, firms seemed to have carved it into local zones served by relatively small-scale national producers. The economists argued that with all barriers to trade removed, there would be a consolidation of these producers, with substantial gains in productivity. These putative gains raised the overall estimated benefits from 1992 to several percent of the initial income of European nations. The Commission economists argued further that there would be indirect benefits because the improved efficiency of the European economy would improve the trade-off between inflation unemployment. At the end of a series of calculations, the Commission estimated a gain from 1992 of 7 percent of European income.2
While nobody involved in this discussion regarded 7 percent as a particularly reliable number, many economists shared the conviction of the Commission that the gains would be large. There were, however, skeptics who suggested that the segmentation of markets had more to do with culture than with trade policy. For example, Italian consumers wanted washing machines that were quite different from those preferred in Germany. Italians tend to buy relatively few clothes, but those they buy are stylish and expensive, so they prefer slow, gentle washing machines that conserve their clothing investment.
Now that a number of years have passed since 1992, it is clear that both the supporters and the skeptics had valid points. In some cases, there have been notable consolidations of industry; for example, Hoover closed its vacuum cleaner plant in France and concentrated all its production in a more efficient plant in Britain. In other cases, old market segmentations have clearly broken down, and sometimes in surprising ways, like the emergence of British sliced bread as a popular item in France. But in still other cases, markets have shown little sign of merging: Germans have shown little taste for imported beer and Italians none for pasta made with soft wheat.
How large were the economic gains from 1992? By 2003, when the European Commission decided to review the effects of the Single European Act, it came up with more modest estimates than it had before 1992: It put the gains at about 1.8 percent of GDP. If this number is correct, it represents a mild disappointment but hardly a failure.