1. 1
European Union Economy
A2 Economics –
Study Companion 2012
Geoff Riley
Tutor2u
January 2012

2. 2
Contents of European Study Companion 2012
1) Background to the European Union........................................................................................................ 3
2) The EU Budget: Financing the Activities of the EU .................................................................................. 4
3) Economic Integration in the EU.............................................................................................................. 5
4) UK Trade with the rest of Europe ........................................................................................................... 7
5) The European Union Single Market........................................................................................................ 8
6) Price Convergence ............................................................................................................................... 12
7) Value Added Tax and Corporation Tax in Europe.................................................................................. 13
8) Business Ownership – Privatisation and Nationalisation in the EU........................................................ 14
9) Measuring the Standard of Living within the EU................................................................................... 17
10) Enlargement of the European Union ................................................................................................ 19
11) EU Enlargement and the impact on the UK economy........................................................................ 23
12) Movement of Labour within the EU.................................................................................................. 25
13) Unemployment in the European Union............................................................................................ 28
14) Policies addressing Income Inequalities in the EU............................................................................. 30
15) EU Competition Policy...................................................................................................................... 32
16) EU Farm Policy and Reform.............................................................................................................. 34
17) Environmental Issues and Policies in the EU..................................................................................... 39
18) European Monetary Union – The Basics of a Single Currency............................................................ 43
19) The UK Economy and the Single Currency ........................................................................................ 53
20) Exam Style Questions on European Economics................................................................................. 55
21) Statistical Snapshot of the European Union...................................................................................... 56
22) Glossary of some key terms.............................................................................................................. 57

3. 3
1) Background to the European Union
There are twenty seven member nations of the
EU – known as EU27. The EU27 includes
Belgium (BE), Bulgaria (BG), the Czech Republic
(CZ), Denmark (DK), Germany (DE), Estonia (EE),
Ireland (IE), Greece (EL), Spain (ES), France (FR),
Italy (IT), Cyprus (CY), Latvia (LV), Lithuania (LT),
Luxembourg (LU), Hungary (HU), Malta (MT),
the Netherlands (NL), Austria (AT), Poland (PL),
Portugal (PT), Romania (RO), Slovenia (SI),
Slovakia (SK), Finland (FI), Sweden (SE) and the
United Kingdom (UK).
Member nations of the Euro Zone
The Euro Area consists of Belgium, Germany,
Ireland, Greece, Spain, France, Italy, Cyprus,
Luxembourg, Malta, the Netherlands, Austria,
Portugal, Slovenia, Slovakia and Finland and
Estonia
Size of the European Union
• The EU accounts for around 30 per cent of the total value of global GDP
• In 2010 – there was a total EU population of 503.6 million (compared to USA pop = 315million)
• Largest population - Germany 81 million, Smallest – Malta 0.4 million, UK – 62 million
• The EU, with 503 million inhabitants, accounts for 7% of the world population
Future Enlargement
• Croatia: Croatia’s application was confirmed in December 2011, she will join in July 2013
• Iceland: Iceland applied to join in 2009, seeking the stability of membership when the global
financial crisis crushed its banking system. It has made good progress in meeting the entry laws
• Former Yugoslav Republic of Macedonia and Turkey are candidate countries
• Albania, Bosnia and Herzegovina, Montenegro, and Serbia are potential applicants although
progress on Serbia’s application has been delayed until the summer of 2012
• Norway and Switzerland are outside of the EU. Norway is a member of the European Economic
Area giving access to EU single market but freedom to pursue her own macroeconomic policies
UK and the EU – the current position
• The UK joined the EU in January 1973. It is inside the single market but outside of the single
European currency – it has an opt out negotiated as part of the 1993 Maastricht Treaty
• The UK is opposed to further fiscal harmonisation and deeper political union (witness the
Cameron approach to Treaty change in December 2011!) but it is broadly in favour of further
enlargement of the single market to bring in more nations from eastern Europe

4. 4
2) The EU Budget: Financing the Activities of the EU
Revenue comes from:
• Import tariffs (customs duties), agricultural duties and sugar levies (16%)
• VAT receipts from member nations (16% of the total income)
• Gross National Income (GNI) based contributions from individual states (67% of total income). –
Note: The GNI ceiling is currently set at 1.24% of the EU’s GNI. Richer nations always pay more.
EU Spending
• Cohesion funds – includes regional funding / money for development projects and transition
into the EU for relatively poorer new member states (sometimes known as “New Europe”)
• Natural resources – farming and fishing payments including rural development funding and
direct financial support for farming and fishing
The UK is a net contributor to the EU budget. In 2011 it paid a net contribution of Euro 12 billion.
1. To some this is one of the major costs of being part of the EU – anti-EU commentators point out that
the UK would be better off financially if we left the EU and operated in a similar fashion to Norway
2. But on grounds of equity it is fair for richer EU nations to contribute more especially if the cohesion
/ structural funds help to sustain a higher rate of growth for the single market as a whole
3. And the UK economy benefits from participation in the single market which generates increased
trade and investment opportunities across many different EU industries
The main criticism of the EU budget is that for many years, too much money has gone on providing generous
but distorting subsidies to agriculture and not enough to funding research and development and improved
infrastructure – both of which could help to lift the trend growth rate of the EU as a whole. The total EU
budget is only 1 per cent of EU GDP – the vast majority of tax and government spending is done by
individual nations of the single market. To raise extra revenue the EU Commission has proposed a new EU
tax which could take several forms: a tax on air transport or a share of new financial, corporate or energy
taxes, or an EU-wide VAT. The UK is likely to oppose this favouring instead reforming EU spending.
During 2011 there was increasing attention paid to French and German-led plans to introduce an EU-wide
Financial Transactions Tax (also known as a Tobin Tax). This is designed to “recover the costs of the recent
and future financial crises” and correct “undesirable” market behaviour, particularly high-frequency trading.

5. 5
3) Economic Integration in the EU
Europe is a huge economic region - The EU (1090bn euro) was the largest exporter of goods in 2009,
followed by China (860bn) and the United States (760bn). The EU (1 200bn) was also the largest importer of
goods in 2009, followed by the United States (1 150bn) and China (720bn).
The development of the EU is a series of stages of economic and political integration between member
nations and also an expansion of the size and scope of the single market.
Integration can take different forms: there is deeper integration as we go down the following list
1. Preferential Trading Area (PTA) e.g. trade agreements between EU and LDCs
2. Free Trade Area (FTA) – breaking down trade barriers within group of countries
3. Customs Union (CU) – free trade plus a common external tariff (CET)
4. Single Market (SM) – built around the four freedoms
5. Monetary Union (MU) – a common currency, one policy rate and central bank
6. Fiscal Union (FU) – the deepest form of integration, requires some political union
In a customs union there is a common external tariff plus free trade between members of the union. This
leads to trade creation and trade diversion effects.
 In 2010 the average EU import tariff for agricultural goods was 12.8%
 The average EU import tariff for non-agricultural goods was 4.0%
Trade creation
Trade creation involves a shift in people’s spending from a higher-cost domestic source to a lower-cost
partner-source within the EU, as a result of the abolition of tariffs. For example, UK consumers may switch
spending on car insurance away from a higher-priced UK supplier towards a German insurance company that
has decided to operate in the UK market. Trade creation stimulates an increase in intra-EU trade and ought
to lead to a more efficient allocation of scarce resources leading to gains in consumer and producer welfare.
Trade diversion
Trade diversion happens when there is a shift in domestic consumer spending away from a lower-cost world
source to a higher cost partner source (e.g. another country within the EU) as a result of the elimination of
tariffs on imports from the partner. The common external tariff on many products entering Europe makes
imports more expensive leading to higher costs for producers and rising prices for consumers if previously
they had access to a cheaper supply from a non-EU country. In general, protectionism results in a
deadweight loss of welfare. Only short-term measures where there is clear evidence of price dumping which
causes material injury to an industry can be defended robustly in terms of economic efficiency.
The overall effect of a customs union on the economic welfare of citizens within a customs union depends
on whether it creates effects that are mainly trade creating or trade diverting. But we must also consider
the impact of these tariffs on the livelihoods of people in countries outside of the EU, for example small-
scale exporters in developing countries for whom EU tariffs provide a stiff barrier to free trade.

6. 6
Trade Creation
Trade Diversion
Always remember the significance of price elasticity of demand and supply in shaping your analysis. Also
consider what happens when you drop certain assumptions behind theory.
Price
Output (Q)
Domestic Demand
Domestic Supply
World Price
QdQs
Pw
World Price + Tariff
Qd2Qs2
Revenue from Tariff
M
Pw + T
Deadweight loss of
welfare from the tariff
Price
Output (Q)
Domestic Demand
Domestic Supply
Supply price from EU supply
Qd2Qs2
EU
Price
Supply price from non-EU
Qd1Qs1
Trade creation – access to
cheaper supplies allows a
lower price – which benefits
consumers
P1
A lower price leads to an
expansion of demand and a
rise in consumer surplus + a
net improvement in
economic welfare

7. 7
4) UK Trade with the rest of Europe
Nearly 55% of UK exports and over half of imports come from the EU. This figure has increased gradually
over the years; a point of contrast is that only 7% of our exports go to the BRIC nations (Brazil, Russia, India
and China). Europe is an importance source of inward investment for example money invested in mergers
and takeovers, portfolio investment in bonds and property and money flowing into commercial banks.
UK exports by destination UK imports by destination
1. European Union (27) 53.6 1. European Union (27) 51.5
2. United States 14.3 2. China 9.4
3. China 2.8 3. United States 9.0
4. Switzerland 2.0 4. Norway 4.7
5. Canada 1.6 5. Canada 2.2
UK Trade to GDP Ratio: 58.8%
UK joined the WTO on 1st
Jan 1995
Source: WTO Trade Profiles – data is for 2010
The UK runs a monthly trade deficit of approximately three billion pounds with the countries inside the Euro
Area. This deficit has barely changed over recent years and is a structural feature of our trade patterns. The
largest trade deficit is with Germany – Europe’s biggest economy and one of the world’s largest exports of
manufactured products such as household appliances, audio-visual equipment and vehicles.
£bn per month, Current Prices, seasonally adjusted
UK Exports to and Imports from the Euro Zone
Exports to Euro Zone countries Imports from Euro Zone countries
Source: Reuters EcoWin
02 03 04 05 06 07 08 09 10 11
billions
7
8
9
10
11
12
13
14
15
16
GBP(billions)
7
8
9
10
11
12
13
14
15
16

8. 8
5) The European Union Single Market
"What we need are strengths which we can only find together. […] We must have the full benefit of a single
large market" (Prime Minister, Margaret Thatcher 1986)
The single market is a deep form of integration between nations and is built upon four key freedoms:
1. Free Trade in Goods: Businesses can sell their products anywhere in the EU’s member states and
consumers can buy where they want with no penalty. Intra-EU trade of goods represents 75% of
intra-EU trade flows. It has increased at an annual rate of 7.6% between 1999 and 2007. For
countries such as the Czech Republic and Hungary, trade with the EU accounts for over 90% of
their trade – showing just how important is the single market to their economic fortunes.
2. Mobility of Labour: Citizens of EU member states can live, study and work in any other country.
The aim is to improve the mobility of labour. For example, every year over 180 000 European
students move to another Member State for the Erasmus programme or to attend a post
graduate degree. But overall, Europe is an area of low geographical mobility with only 2.3% of
Europeans living in a Member State different from that of their nationality. This figure is three
times higher in the United States. An estimated 12m European citizen live in an EU country other
than their own – equivalent to the population of Belgium or Greece.
3. Free Movement of Capital: Currencies and capital can flow freely between member states and
EU citizens can use financial services in any member state.
4. Free Trade in Services: Professional services such as pensions, architecture, telecommunications
and advertising can be offered in any member state. Services account for over 70 per cent of
GDP in many EU countries. But progress in expanding intra-EU trade in services has been slow.
At present, only 20% of the services provided in the EU have a cross-border dimension
Single market and economic concepts
1. Productivity:
a. The EU Single Market is designed to create a “positive sum game” for member states if
trade and competition leads to higher productivity and brings about lower costs for
producers and eventually cheaper prices for consumers.
b. Stronger competition encourages industrial restructuring because exposure to other
markets causes businesses to re-organise their management (improving X-efficiency) to
minimise costs
2. Lower prices and higher real incomes: Lower prices should boost consumers' real living
standards and an increase in competition will lead to improved allocative efficiency and less
waste. This might mean for example lower fares for airlines, cheaper prices for mobile calls or
reduced costs for car and home insurance if European markets are more contestable.
3. Economies of scale: Firms selling in the Single Market have (in principle) unrestricted access to
over 500 million consumers in the EU. The size of market allows businesses to exploit economies
of scale leading to improvements in productive efficiency. For example UK retailers such as
Tesco have successfully made in-roads into the retail markets of many EU countries earning
profits that flow back into the UK. Foreign retailers have entered UK high streets too!

9. 9
4. Labour mobility: There are economic and social costs and benefits from a freer movement of
labour - these are discussed in a separate section of this revision companion. Migration flows
have increased significantly since ten new member states have joined the EU after 2004.
5. Price convergence: Competition should lead to a process of price convergence between
countries meaning that the gap between what we pay from one country to another for the same
product should fall - but there will always be price variations within EU for the same products
such as basic foods, new cars and products such as iPads and smart-phones.
6. Business alliances and joint ventures: The single market encourages cross-border technological
alliances and joint ventures – boosting dynamic efficiency and competitiveness.
7. Economic growth and resilience to external shocks: A stronger internal EU economy with an
improving trend growth rate of potential GDP may be less vulnerable to global external shocks
and better able to reduce unemployment. The global financial crisis and subsequent recession
throughout Europe has allowed us to see how resilient the EU single market is.
8. In short the single market is designed to accelerate the gains from specialisation and trade
between participating nations.
Economies of Scale
Intra-European Trade
Key to all of this is to remember that the EU is a customs union. This means that the EU levies duties on
imported goods and services coming into the region. But there is free trade within the market. This causes a
rise in intra-EU trade. A recent EU report found that Intra-European trade currently accounts for 17% and
28% of world trade in goods and services respectively.
Taking services as a separate case, over 30% of intra-European trade in services is in the travel industry,
followed by transport (around 20%) and insurance and finance (10%). But health care remains largely within
national borders. There has been some increase in the demand for and willingness to pay for “health
tourism” services (especially treatments that are cheap in Eastern Europe) but little investment by
multinational health care businesses in different EU countries.
Costs
Revenues
Output (Q)MES
LRAC
Increasing return to scale – economies of
scale - falling LRAC
Decreasing returns –
diseconomies of scale

10. 10
The Single Market, Investment, Takeovers and Mergers
We have seen a lot of cross-border investment. There are many motivations for this including the following:
1. Resource seeking – where a business seeks resources which are unavailable in the home country
2. Efficiency seeking – e.g. businesses seeking to benefit from a more productive workforce, lower
wages or from the external economies of scale available in a region.
3. Market seeking – e.g. investment to take commercial advantage of growing demand in faster-
growing emerging market countries
Vertical foreign investment
For example, Nokia produces mobile phone components and batteries in Hungary and assembles phones in
Germany and Finland, where it also has research and development facilities.
Horizontal foreign investment
For example car manufacturers investing in several European countries
Takeovers and mergers
In recent years there have been many examples of businesses looking to integrate or form joint ventures to
establish or grow their positions across the EU single market. Here are some recent examples:
• Arriva, the UK bus and rail operator was bought by Deutsche Bahn
• British Airways merged with Spanish airline Iberia in January 2011 to form IAG
• British healthcare group Alliance Boots acquired German drug distributor Andreae-Noris Zahn
• Dutch LWM potatoes group agreed a takeover of Austrian frozen food producer Frisch & Frost
• Incumbent postal operators, Posten (of Sweden) merged with Post Danmark
• Spain's Banco Santander acquired Poland's Bank Zachodni from Allied Irish Banks
• Spanish Bank Banco Santander acquired 318 branches of Royal Bank of Scotland (RBS)
• Tesco acquired 128 Penta convenience stores in the Czech Republic
Putting the EU Single Market in Context
The EU internal market does not operate in isolation. There are many external forces influencing growth,
prices, investment and jobs within the EU. The single market has been affected for example by:
1. Financial instability – for example the sub-prime mortgage crisis in the United States
2. Globalization and the emergence of new powers such as the BRIC countries (Brazil, Russia, India
and China) – the balance of power and influence in the world economy is shifting rapidly
3. Political changes including the collapse of the Soviet bloc and turbulent international relations
to the east of the European Union for example Russian-Ukrainian relationships
4. Increase in labour migrations and in greater cultural diversity around the world
5. The technological revolution, triggered by Information and Communication Technology;
6. The growing importance of services in the economy and the rise of global digital technologies
7. The growing awareness of environmental and climate-change challenges and international
pressures to introduce policies to address these issues

11. 11
Barriers to the successful completion of the EU single market
The EU market is not complete. Despite claims by politicians, there remain plenty of barriers to and costs of
supplying goods and services across all twenty seven members of the European Union. Services in particular
are seen as an area of the single market that is a long way off allowing genuinely free trade and open access.
State Aid: One of the controversial issues during the recession has been extensive use of state aid as a way
of a government supporting and protecting their own interests. Sectors such as the financial industry,
airlines, car manufacturers and tourism have been granted billions of Euros in aid to survive the recession. In
the UK, the RBS received over £45 billion of state aid from the UK government.
 Aid pledged to Europe's banks hits 4.5 trillion Euros (BBC news, December 2010)
 EU takes Greece to court over tax breaks (BBC news, February 2010)
 Osborne launches a loan guarantee scheme for banks lending to small and medium-sized enterprises
Intellectual property: At present patents on innovations and invention have to be enforced on a country-by-
country basis and this makes the cost of intellectual property protection much higher in Europe than for
example in the United State of Japan. There have been calls for a single European patent law. According to
the Financial Times, patenting an idea in the USA is at least 10 times cheaper than in Europe
Labour mobility: We cover labour migration in a separate section of this revision guide. But in recent years
several EU countries have tightened up their labour migration policies in a bid to control the volumes of
people moving into their countries seeking work.
Because there are now twenty seven countries in the EU it becomes harder and more time-consuming to get
all countries to agree on policies that might help make the single market more complete.
Reforming the EU Single Market - The Monti Report – May 2010
In June 2010 Professor Mario Monti identified a range of reforms that are required to make the internal
market work better. He argued that the single market suffers from bottlenecks that prevent true
competition from being established across every member nation.
His suggested reforms include:
1. A European Free Movement Card to make it easier for people to move around the EU
2. Abolish double taxation of registration for cars so that motorists and car hire firms can move
their cars more easily across the twenty seven nations
3. Greater protection for consumers who buy products from suppliers in other EU countries
4. Adopt the Statute for a European Private Company to make it easier to set up new businesses
5. Proposal for an EU copyright law and measures to boost EU online broadcasting
6. Reforms for EU energy markets including regulatory support for smart metering, smart grids
and transparent wholesale energy markets (especially in gas)
7. Step up targeted EU funding for energy infrastructure especially in new member states
8. Establish a single market for green products, by developing EU-wide standards for measuring
and auditing carbon footprints and for energy efficient products
9. Adopt a single European Patent Act to boost research and innovation

12. 12
6) Price Convergence
Price convergence means that the gap in prices between different regions or countries for the same good or
service has fallen. An EU single market and nearly ten years of having a single currency ought in theory to
provide the conditions for price variations to come down:
1. More intense competition between businesses and less scope for monopoly pricing
2. Having one currency ought to make it easier for consumers to compare prices and buy from the
cheapest seller because of price transparency
3. Developments in web technology also make it easier for price comparisons and buying from
cheaper suppliers.
This chart provides some evidence of price convergence
But despite this there are specific market factors for why the same products often sell for different prices:
• Variations in indirect taxes such as VAT and other duties
• Geographical location and transport costs – affecting the cost of getting products to consumers
• Retailers’ real estate costs including the costs of renting stores
• Differences in average wages throughout the EU and variations in minimum wage levels
• Differences in per capita incomes within Europe and also variations in consumer price elasticity
of demand for different products (this affects the pricing power of manufacturers and retailers)
• Uneven degrees of competition – for example the UK food retailing sector is widely regarded as
highly competitive with frequent price wars between the major retail businesses
The lower the figure, the closer are consumer prices for countries within the EU
Price Convergence Indicator for the EU
Source: Reuters EcoWin
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
10
15
20
25
30
35
40
45
%
10
15
20
25
30
35
40
45
27 nations of the EU
Countries inside the Euro Zone

13. 13
7) Value Added Tax and Corporation Tax in Europe
One important aspect of the single market is the continued freedom of member countries to set their own
tax levels for consumers and businesses. Although there are many senior EU figures who wish to see greater
tax harmonisation across countries, the UK position is that decisions on taxation are best left to individual
governments who often have different economic, social, political and environmental priorities.
Tax rates for selected EU countries Corporate tax Standard VAT rate
Austria 25% 20%
Belgium 34% 21%
Bulgaria 10% 20%
Czech Republic 21% 20%
Denmark 25% 25%
Estonia 20% 20%
Finland 26% 23%
France 33.33% 19.6%
Germany 15.8% Federal rate + local rate 19%
Greece 25% 23%
Hungary 16% 25%
Ireland 12.50% 21%
Italy 31.40% 20%
Latvia 15% 21%
Luxembourg 28% 15%
Netherlands 25.50% 19%
Poland 19% 22%
Portugal 27.50% 23%
Romania 16% 24%
Slovakia 19% 19%
Slovenia 20% 20%
Spain 30% 18%
Sweden 26.30% 25%
United Kingdom 21%-28% 20.00%
• Some countries have deliberately used lower corporate tax rates as carrot to attract inward
investment. Ireland was among the first to try this and succeeded in getting significant amounts
of investment from the USA and elsewhere. Many of Europe’s new member states have also
engaged in “tax competition” to bring in fresh investment. Bulgaria, Hungary and Romania are
three such examples
• Once applied to a product, there is a minimum rate of VAT in Europe of 5% and there are also
minimum duty rates for cigarettes.
• There are also sizeable differences in excise duties from one country to another – for example
the duties placed on cigarettes, alcohol and fuel. This directly affects the cost of living in one
European country compared to another.

14. 14
8) Business Ownership – Privatisation and Nationalisation in the EU
The balance of ownership between public and private sectors within Europe is always changing. This short
section provides an overview of state and private sectors in some EU countries.
Privatisation
Privatisation means the transfer of assets from the public (government) sector to the private sector. In the
UK the process has led to a sizeable reduction in the size of the public sector. State-owned enterprises now
contribute less than 2% of GDP and less than 1.5% of total employment. Privatisation has become a key
microeconomic reform in the transition economies of Eastern Europe. But in recent times, privatisation in
the UK has given way to a new wave of nationalisation including some high profile banks, building societies
and transport services. Nationalisation has also happened in other Western European countries.
Nationalisation
This is where a business (or perhaps en entire industry) is in the partial or whole ownership of the State.
Public sector businesses often operate on commercial lines but their objectives may differ from enterprises
listed on stock markets – usually there is greater weight given to politically important targets and objectives.
The scale of state ownership varies across Europe.
 Germany has a social market economy with a strong private sector underpinned by state ownership
in certain key industries - public sector businesses include government stakes in Deutsche Bahn,
Deutsche Post, Deutsche Telekom and Deutsche Postbank. State governments own shares in a
number of companies including carmaker Volkswagen. During the financial crisis the German
mortgage bank Hypo Real Estate, deemed too important to fail, was taken into full state ownership.
 French governments have traditionally played an important role in industry, arranging takeovers
and mergers and offering financial support (including whole or partial ownership) in a number of
businesses. Examples include Although France's state-owned nuclear corporation, Areva SNCF (the
state-owned train operator) EDF energy, France Télécom, EADS (owner of Airbus) and Renault.
 In many eastern European countries the collapse of communism in the late 1980s and early 1990s
brought about wholesale privatisation of many state assets. And this part of the transition process
has continued since many CEE nations joined the European Union in 2004 and 2007. In Poland for
example, the number of enterprises in which the government holds stakes fell to 1,090 at the end of
2009 from more than 8,400 in 1990.
Here are some examples of planned privatisations among this group of countries:
1. Bulgaria plans to privatise the state-owned cigarette maker Bulgartabak
2. Croatia is selling off six loss-making shipyards - a key condition for progress in EU accession talks
3. The Czech Republic is selling off the state-owned Czech Airlines and Prague Airport
4. The Hungarian government wants to privatise drug maker Gideon Richter
5. Poland is privatising firms in the telecoms and energy sectors

15. 15
Nationalisation in Britain: Public sector businesses include:
1. Network Rail - a "not for dividend" company that owns the fixed assets of the UK railway system
East Coast Rail Line - a train operating company nationalised in June 2009
2. Royal Mail Ltd - Royal Mail has been a state-owned company since 1969. The Coalition Government
has plans to part-privatise the Royal Mail in the near future. The Royal Mail Group includes Post
Offices and the Parcel Force business
3. Bradford and Bingley - In 2008 the government took control of the bank's £50bn mortgages and
loans, while B&B's £20bn savings unit and branches was bought by Spain's Santander Bank
4. Royal Bank of Scotland (RBS): On the 13 October 2008 the government bailed out the bank in return
for a 70% stake in it. The government also has a 43 per cent stake in Lloyds Banking Group
2011 Developments:
 In July 2011, the state-owned Tote bookmakers was sold to betting firm Bet Fred
 Northern Rock plc was nationalised in 2008 after becoming the first commercial bank to suffer a
depositor run for more than 100 years. After a few years in state-ownership, on 17 November 2011
Virgin Money announced an agreement to buy Northern Rock plc for £747 million up front and other
potential payments of up to £280 million over the next few years
Airlines in Europe – the controversy over state aid
In many EU countries the government owns a sizeable or a controlling stake in one or more airlines. These
are known as flagship carriers with strategic significance even if many suffer heavy losses.
 Austrian Airlines 40%
 Belgium - Sabena 34%
 Cyprus - Cyprus Airways 69%
 Czech Republic - CSA Czech Airlines 94%
 Denmark - Scandinavian Airlines 50%
 Finland - Finnair 60%
 France - Air France 18%
 Greece - Olympic Airlines 100%
 Ireland - Aer Lingus 25%
 Italy - Alitalia 50%
 Netherlands- KLM Royal Dutch 6%
 Poland - LOT Polish Airlines 68%
The recession hit the aviation industry hard bringing about growing losses for many airlines. Global airlines
made losses of $9bn in 2009 due to falling revenues and rising costs including expensive aviation fuel prices.
In Europe, a fall in passenger and cargo demand resulted in significant losses for many carriers and the
restructuring of the sector. The downturn in average fares, passenger numbers and freight has put the issue
of state support for some European airlines into the spotlight.
The restructuring took the form of intensified horizontal cooperation within global airline alliances resulting
in joint venture agreements covering transatlantic routes. There were also some important mergers
involving large network carriers such as Delta/Lufthansa and British Airlines joining up with Iberia (Spain)
An association of (largely profitable) low-cost airlines in Europe such as FlyBe, easyJet, Jet2 and RyanAir has
complained to the EU commission that government support to established airlines is in breach of EU
competition laws on state aid. Emergency support is allowed under EU rules for the rescue and restructuring
of firms in difficulty. But repeated flows of funding are not allowed - indeed state aid can only be granted
once over a 10-year period. The low cost airlines complain that state owned and subsidised airlines are a
form of indirect protectionism in the EU aviation industry.

16. 16
Losses for airlines
The diagram below provides a simple analysis of when airlines suffer losses. At the profit maximising output
Q1 the average cost of production is greater than the average fare leading to a loss per unit.
Should EU governments provide financial assistance to loss-making airlines?
The case for state aid / subsidy:
1. If airlines go bust many thousands of well-paid and highly-skilled jobs will be lost in the aviation
industry – both in the airlines, manufacturers of aviation equipment and in related service industries
2. These job losses and corporate failures will bring about negative multiplier and accelerator effects
3. Aid funds rescue & restructuring for the airline industry for the long run benefit of the EU economy
4. The circumstances facing airlines are uniquely difficult – credit crunch, avian flu, volcanic ash, highly
volatile oil prices, terrorist threats – and justify some support to maintain a stable aviation industry
Arguments against state aid:
1. There is little market failure here that might justify state financial support. Subsidising loss-making
airlines distorts the market and is inequitable to other profit making airlines
2. It gives one airline an advantage over others and goes against the principles of the single market
3. If airlines are state owned and bailed out this might cause a loss of dynamic efficiency and the
problem of moral hazard (the knowledge that risks can be taken because support is there)
4. Billions of Euros of state aid have an opportunity cost and might be better spent in alternatives such
as improving high-speed rail networks. Either way – the EU taxpayer eventually pays for this.
5. If airlines are given special state help why not other industries? Aid doesn’t solve structural problems
facing the EU aviation industry.

17. 17
9) Measuring the Standard of Living within the EU
1. The base line measure of living standards is real per capita national income adjusted to express
the data at a purchasing power standard
2. GDP per capita in the EU Member States ranged from 44% to 271% of the EU27 average in 2010
3. Luxembourg has the highest per capita incomes whilst Ireland, Denmark, Austria and Sweden
are between 20% and 30% above the EU27 average. The United Kingdom registered GDP per
capita around 10% above the EU27 average, while Italy, Spain and Cyprus were at the average
4. Hungary, Estonia, Poland, Lithuania and Latvia were between 35% and 50% lower, while
Romania and Bulgaria were around 55% below the EU27 average.
GDP per capita is a flawed measure of living standards. Official measures of living standards ignores
1. The informal economy where products are not traded at officially measured market prices
2. The size of the illegal shadow economy
3. Length of the working week and the standard of employment conditions
4. Extent and cost of externalities from consumption and production
5. Income & regional inequality factors including differences in Gini Coefficient
6. Quality of life variables such as educational and health provision; the quality and availability of
public services, the risk of crime and various indicators of social exclusion and deprivation
7. Levels of disposable income – variations in direct and indirect taxation
GDP per head, purchasing power parity adjusted, EU27=100
Per Capita GDP for selected EU Countries
Source: Reuters EcoWin
99 00 01 02 03 04 05 06 07 08 09 10
80
90
100
110
120
130
140
150
EU27=100
80
90
100
110
120
130
140
150
Germany
UK
Italy
Spain
Greece
Ireland

18. 18
Consumption per head
This is an alternative approach to measuring relative living standards – i.e. the ability of households to
consume goods and services regardless of whether or not they have to pay for them. The EU now publishes
data on this and for 2010 they found that consumption per capita in the UK was 20% above the UK average
with Britain's rating boosted by public services such as health and education – largely government funded.
Bulgaria (who joined the EU in 2007) was judged to have the lowest standard of living, 58pc below that of
the EU average.
Consumer prices in Europe
This data is used to help estimate purchasing power parity measures of income and consumption per head.
Retail prices in the UK were 2% above the EU27 average in 2010, while Denmark was the most expensive at
47% above the average. Bulgaria was the least expensive, at 55% below the average.
Income inequality in Europe
Data on income per head gives us a sense of average living standards. But mean incomes per head of the
population tend to hide what can be deep and extensive inequalities in income and wealth.
A commonly used measure of income inequality is the Gini coefficient, which is based on the cumulative
share of income accounted for by the cumulative percentages of the number of individuals, with values
ranging from 0 per cent (complete equality) to 100 per cent (complete inequality). As our table below shows,
the estimated Gini coefficients in Europe vary a lot across countries.
Selected EU
countries
Gini Coefficient
(data for 2008)
Gross domestic product per
head, PPP adjusted, data
for 2009
Comparative price
levels in 2009 (EU-27
=100)
Median Household
Earnings Thousand Euros
per year in 2008
Portugal 0.38 80 87 11
Greece 0.36 93 97 19
Italy 0.36 104 107 26
United Kingdom 0.36 112 96 35
Poland 0.35 61 54 6
Spain 0.35 103 98 19
Ireland 0.34 127 131 36
Belgium 0.33 116 118 34
France 0.33 108 114 26
Romania 0.32 46 51 3
Netherlands 0.31 131 110 30
Hungary 0.30 65 59 6
Bulgaria 0.29 44 44 1
Germany 0.28 116 105 34
Finland 0.27 113 125 29
Czech Republic 0.26 82 65 8
Denmark 0.25 121 150 43
Sweden 0.25 118 112 30

19. 19
10) Enlargement of the European Union
The expansion of the EU to embrace more countries has been perhaps the most important development in
Europe in many years. There have been six main waves of enlargement.
 1973 (UK, Ireland and Denmark)
 1981 (Greece)
 1986 (Portugal and Spain)
 1995 (Austria, Finland and Sweden)
 2004 (Latvia, Lithuania, Cyprus, Malta, Slovenia, Slovakia, Estonia, Hungary, Czech Republic, Poland)
 2007 (Accession of Bulgaria and Romania)
Advantages for new EU countries
For new EU members the opportunities of participating in the EU single market have been centred on
attracting high levels of inward investment, and promoting development through free trade access to the
higher-income consumers of richer EU nations. Inward investment was attracted to countries with low
relative unit labour costs and where expected growth of per capita incomes was high.
In addition they have been recipients of EU funding -- which have financed road construction,
environmental clean-up schemes, job training and other supply-side projects.
Index of GDP per head, purchasing power standard, EU=100
Income convergence for ten new EU members
Czech Republic
Hungary
Poland
Slovenia
Estonia
Slovak Republic
Bulgaria
Lithuania
Latvia
Romania
Source: Euro Stat
00 01 02 03 04 05 06 07 08 09 10
20
30
40
50
60
70
80
90
100
EU27=100
20
30
40
50
60
70
80
90
100

20. 20
As our chart shows there has been limited progress in achieving convergence in per capita incomes although
progress towards income convergence has been stalled because of the effects of the recent recession
The macroeconomic performance of new EU nations
 Enlargement occurred during a period of strong growth (driven by a rapid expansion of exports in an
era of globalisation) and the boost from low inflation and interest rates. One can argue that this was
an opportune time to widen the EU single market – macroeconomic conditions were favourable.
 But progress made by new EU members has not been even – most have achieved a degree of
income convergence and have managed to bring down unemployment levels. But there have also
been underlying problems – notably property bubbles, rising consumer debts, high inflation,
current account deficits on the balance of payments and the effects of depopulation as migrant
workers from central and eastern European countries in particular moved west in search of work
and higher incomes. To these short term problems we can add the issues of an ageing and declining
population in many eastern European countries.
The global credit crunch and ensuing international slowdown and recession hit the EU hard and the impact
spread into many new member states. Many suffered a deep recession and their first major downturn since
the post-communist chaos of the early 1990s. This created severe economic, social and political problems.
The worst-affected countries were heavily dependent on the Euro Area for investment and exports but were
eventually helped by a fall in their exchange rate against the Euro in 2009.
Several new member states allowed a property bubble to develop in the early years of the current decade.
The recession in these countries was made worse by property price deflation and also by large borrowing
made in Euros. Many of their currencies depreciated against the Euro - making it harder to service debt
issued in Euros – and some currencies outside of the Euro have come under speculative attack. There has
also been a partial loss of investor confidence in central and Eastern Europe – leading to some reversal of
FDI flows – which have been a major source of growth and new jobs over recent years.
Country Focus: Poland
Poland Macro Indicators 2007 2008 2009 2010 2011
Real GDP (% change) 6.8 5.0 1.7 3.5 4.0
Consumer spending (% change) 4.8 5.3 2.6 2.5 3.0
Capital investment (% change) 17.3 9.7 -0.7 -0.6 17.8
Exports (% change) 9.1 5.8 -6.0 11.6 5.8
Imports (% change) 13.7 6.2 -13.2 11.7 8.4
Unemployment rate (% of the labour force) 9.6 7.1 8.2 9.6 8.9
Fiscal balance (% of GDP) -1.9 -3.7 -6.8 -7.9 -6.7
Official policy interest rates (per cent) 4.8 6.3 4.3 4.1 5.6
Consumer price inflation (per cent) 2.4 4.2 3.8 2.4 2.5
Balance of Payments Current Account (% of GDP) -4.7 -4.8 -2.2 -2.4 -3.2
Poland is the largest of the new members of the EU and is widely regarded as having avoided the worst
effects of the global financial crisis and European recession. As the table shows, real GDP growth slowed
sharply in 2009 from the 5 per cent plus annual growth rates achieved in the first half of the decade. But a
full-blown recession was avoided and growth recovered strongly in 2010 and 2011. Poland’s economy has

21. 21
been consistently growing during the European crisis although their economy is not isolated from the
difficulties in the Euro Zone.
One reason for Poland’s relative success during 2009-10 was depreciation in the external value of their
currency – the Zloty. The fall in the value of the Zloty (after a number of years when the Polish currency
appreciated against the Euro) helped to boost the price competitiveness of Polish exports within the EU
single market at a time when European trade was weak because of the recession. The Polish central bank
was also able to cut official policy interest rates from 6% to 4% and the government’s budget deficit
expanded to over 6% of GDP as their fiscal stimulus kicked-in.
The result has been a relatively stable outcome for Poland. Their inflation rate is under control and exports
rebounded strongly in 2010 with an increase of nearly 12 per cent. Progress in reducing unemployment has
halted because of the slowdown but Poland has not suffered the steep rise in jobless totals of some fragile
Euro Area countries such as Spain, Ireland, Italy and Greece.
“Poland’s proximity to Germany and a cheap, qualified workforce has made it a natural destination for investors. In
1991 – the last year in which Poland’s economy contracted – GDP per capita in current dollar terms was $5,612
(€4,212), according to the International Monetary Fund, about a quarter of the level in Germany. Last year, Poland’s
GDP per capita was $18,981, about half of Germany’s.” Source: FT review of the Polish economy, 2011
Recently Poland has been re-classified by the World Bank as a high-income country. It remains an attractive
location for inward investment and seems to have established itself well within the single market. The newly
elected Polish government is committed to joining the Euro because they believe it is an integral part of the
European project. That said being outside of the Euro Zone may have helped the Polish economy to weather
the worst of the effects of the financial crisis in recent times.
Top Pane: Real GDP Bottom Pane: Effective Exchange Rate Index
Poland - Growth of Real GDP and the Exchange Rate
Poland, Real GDP, precentage change from previous period, Constant Prices
Effective Exchange Rate Index
Source: Reuters EcoWin
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct
07 08 09 10 11
85
90
95
100
105
110
115
120
125
130
Index
85
90
95
100
105
110
115
120
125
130
0
1
2
3
4
5
6
7
Percent
0
1
2
3
4
5
6
7
Poland - Real GDP Growth Rate

22. 22
The long term progress of Poland in lifting productivity and incomes per head is shown in the chart below
The Polish economy is a good example of a country that has benefitted from EU structural funds to help
finance much needed capital investment. Poland currently receives €67bn over a 5 years period in structural
funds from the EU budget. Much of this money is allocated to addressing a deep infrastructure gap including
a very poor road and rail network. In 2011, about 250km of motorways will be completed, with the most
important segment being a 105km section that will finally link the German border with the central Polish city
of Poznan. Poland is the only EU country not to have been in recession in the past 20 years
Poland’s Trade Profile
Note here how dependent Poland is for her trade with the European Union. Nearly 80% of exports are sold
to fellow members of the EU contrasted with 55% for the UK. Less than 2% of exports go to the USA.
Poland’s exports by destination Poland’s imports by destination
1. European Union (27) 79.4 1. European Union (27) 61.6
2. Russian Federation 3.7 2. China 9.2
3. Ukraine 2.5 3. Russian Federation 8.6
4. Norway 1.9 4. South Korea 3.0
5. United States 1.8 5. United States 2.3
Trade to GDP Ratio: 82.2%
Poland joined the WTO on 1st
Jan 1995
Source: WTO Trade Profiles – data is for 2010
Annual figures
Poland - Progress in lifting Productivity and Income Per Head
GDP per Capita in PPS Labour Productivity per Person Employed
Source: EU Commission
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
40.0
45.0
50.0
55.0
60.0
65.0
70.0
EU27=100
40.0
45.0
50.0
55.0
60.0
65.0
70.0
Labour productivity relative to EU average (EU27=100)
Income per head relative to EU27 average (100)

23. 23
11) EU Enlargement and the impact on the UK economy
“Eastward enlargement has been one of the EU’s greatest successes. By opening its doors and stretching out a helping
hand, the EU has contributed to transforming 13 central and eastern European countries from post-communist
confusion into open market, well-functioning democracies. Of course the EU’s new members aren’t perfect; the 2008-09
global financial crises have laid bare their weaknesses. The fight against corruption, cronyism and crime has slowed in
some places, and massive investments in skills, technology and infrastructure are still needed to bring the eastern
Europeans up to western European living standards. There is no doubt that people in the new EU countries live longer,
healthier, happier and more secure lives than they would otherwise enjoy”
(Source: Katinka Barysch, Chief Economist of Centre for European Reform)
Advantages of EU enlargement for the UK
The UK government favours bringing more countries into the EU partly because of a belief that the UK’s
economic performance can improve as a result (economists term this a “positive-sum game”). Among the
benefits cited from having more countries within the market here are four key ones:
(1) Export Potential: There are trade creation effects from increasing the size of a customs union.
Britain can now source some of her imports of goods and services more cheaply leading to an
improvement in her terms of trade. Efficiency should increase as resources are diverted to areas
of the UK’s comparative advantage.
(2) Exploitation of economies of scale from supplying to a larger market: As the size of the
European market increases and accession countries become richer creating new demand for
Exports of goods and services, annual data, current prices, £ billion
UK Exports to some new EU States
Poland
Slovakia
Hungary
Czech Republic
00 01 02 03 04 05 06 07 08 09 10
billions
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
GBP(billions)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
These countries joined the EU in May 2004

24. 24
goods and services. For example, the value of British exports to Poland (at current prices) has
more than doubled since Poland’s accession to the EU in 2004 reaching nearly £5bn in 2010
(3) Foreign Investment and Incomes and Profits: Foreign investment by British firms into Europe’s
newest states will provide a flow of interest profits and dividends thereby boosting our GNP and
supporting the current account of the balance of payments. FDI will also help to speed up the
economic transformation of Europe’s new countries.
(4) A more diverse European labour market: There are now greater opportunities for British
businesses to import lower-cost skilled labour in areas where there are labour shortages. The
migration of labour from accession countries was larger than many economists predicted in
2004 but during the strong growth years of 2005-2008, inward migration into the UK helped to
offset some of the longer-term effects of ageing populations and the slow growth of the
population of working age. It kept wage inflation and consumer price inflation lower than would
otherwise be the case and may have contributed to a higher level of potential national income.
Risks of EU Enlargement for the UK
(1) Extra budgetary costs for financing EU programmes – most of the new member states of the EU
are relatively poor in terms of real GDP per capita and the EU has raised the size of their
spending on cohesion funds much of which has been targeted at relatively poorer countries and
regions.
(2) Social and economic pressures from inward labour migration – this is covered in a separate
chapter
(3) A shift or displacement of foreign direct investment and jobs to Eastern Europe – partly driven
by tax competition and by lower unit labour costs.
Next Steps
The EU will enlarge further in future years but the pace of this is open to question in the wake of the global
financial crisis. There are numerous pre-entry conditions that have to be met by any country seeking EU
membership, but it seems that Croatia’s entry into the EU will pass through relatively untroubled. And there
have been some suggestions that Iceland might seek entry to the single market. In July 2009 Iceland
formally submitted an EU membership application. Effectively it is already part of the single market and over
seventy per cent of its trade is with other EU countries. Serbia, Albania and Montenegro are also candidate
countries to expand the single market to thirty countries or more.
But the biggest and most controversial enlargement would be that of Turkey.
After several years of discussion, negotiations between the EU and Turkey seem to have stalled for the time
being. Turkey does not recognise the legitimacy of the Greek Cypriot government but the EU insists that
Turkey opens its ports and airports to ships and planes coming from Cyprus. Turkey is insisting that EU takes
steps to end the isolation of the Turkish Cypriots, such as allowing them to trade freely with EU countries.
Human rights remain an intractable issue between the politicians. Finland, Italy, Sweden, Spain and the UK,
remain strongly in favour of Turkish membership. The Dutch, Austrians and Germans are more sceptical.
Although Turkey remains outside of the EU – it does share with them a common external tariff arrangement.

25. 25
12) Movement of Labour within the EU
“Since 2004 an estimated one million Poles have settled in Britain, taking advantage of the higher wages British
employers were prepared to pay. They became so much a part of the country’s life that Tesco, Asda and Sainsbury’s and
small local shops—started stocking Polish food and drink, and libraries began to stock books and newspapers in Polish.
… …Polish builders, with a reputation for working long hours at a fraction of the price local workers charge, has spent
four years forcing their British rivals to raise their game.” (Source: The Times Newspaper, February 16, 2008)
Inward migration into the UK
For most of this decade, Britain has experienced a significant level of net inward migration, where many
more people were coming into the UK to live and work than were leaving. Many of these people have come
to the UK from other EU countries especially the new member states of Eastern Europe. Free movement of
labour is one of the guiding principles of the EU single market. So in 2004 when the eight Central European
countries Czech Republic, Estonia, Hungary, Latvia, Lithuania, Slovenia, Slovakia and Poland joined the EU a
debate started about immigration into the UK that has barely stopped since.
Basic data on inward migration from Central and Eastern European Countries
Official data shows that between 2004 and the first
quarter 2009, the share of immigrants from these
countries as a proportion of the UK population increased
from 0.01% to 0.9%, comprising 1.3% of the working age
population in 2009. The data shows that EU immigrants
are substantially younger and better educated than the
native population.
Nearly two thirds of the migrants coming to the UK from
central and eastern European countries have been from
Poland. The number of migrants from Poland has started
to decline but in the spring of2010 there were still over
half a million Pole living in the UK.
Many factors affect the rate of migration. Some of them
are summarised below. In general, the incentive to migrate is strongest when the expected increase in
earnings exceeds the cost of relocation.
(1) Differences between countries in wages and salaries on offer for equivalent jobs
(2) Access to the benefits system of host countries plus state education, housing and health care
(3) Employment opportunities vary between nations, in particular for younger workers
(4) A desire to travel, learn a new language and pick up new skills and qualifications
(5) A desire to escape political repression and corruption in the country of origin
(6) The impact of satellite television and the internet in changing people’s expectations
(7) The effects of cheaper phone calls and more affordable air travel and coach travel
(8) The unwillingness of people within the domestic economy to take certain “drudge-filled” jobs
such as porters, cleaners and petrol attendants

26. 26
The effects of labour migration on the labour markets of richer nations inside the European Union including
the UK depend on where the main source of competitive advantage lies, according to research from
Marques and Metcalf in a paper delivered to the Royal Economic Society. They argued that industries that
source their competitive advantage from a large,
skilled workforce will have gained from an influx
of younger, well-educated workers. Industries
such as high-knowledge manufacturing,
transportation and financial services may well
gain from an increase supply of skilled workers
from Eastern Europe.
In contrast industries that rely on low-educated
labour-intensive workers will lose out because
production will gravitate to countries where unit
labour costs are lower. Examples of include
textiles and clothing and leisure sectors where
there has been a shift of production towards
emerging economies in the Far East.
Source: Office for UK National Statistics: http://www.statistics.gov.uk/cci/nugget.asp?id=260 accessed Dec 2010
Has migration from other EU countries benefitted the UK?
Have migrant workers provided a boost to the competitiveness and supply-side capacity of the UK economy?
The debate will rage on for many years and it is important to be aware that with this kind of controversial
issue, many of those putting forward evidence will be using normative economics heavily laden with value
judgements and will often use data selectively to push their own point of view.
Supporters of inward migration have argued that migration provides:
(1) Fresh skills: Migrants can provide complementary skills to domestic workers, which can raise the
productivity of both (a child minder from the Czech Republic provides good quality child care at
an affordable price which allows a highly paid female magazine editor to continue to work.)
(2) Driver of innovation and entrepreneurship: Inward migration can also be a driver of
technological change and a fresh source of entrepreneurs. Much innovation comes from the
work of teams of people who have different perspectives and experiences.
(3) Multiplier effects: New workers create new jobs, there is a multiplier effect if they find work and
contribute to a nation’s GDP through a higher level of aggregate demand.
(4) Reducing labour shortages: Migration can help to relieve labour shortages and help to control
wage inflation. This can reduce the non-accelerating inflation rate of unemployment (NAIRU.)
(5) Income flows: Remittances sent home by migrants can add substantially to the GNP of the home
nations. And if these remittances boost spending in these countries, this creates a fresh demand
for the exports of other nations.
(6) Tax revenues: Legal immigrants in work pay direct and indirect taxes and are likely to be net
contributors to the government’s finances.

27. 27
Opponents of unrestricted migration argue that high levels of inward migration create economic and social
tensions and costs for the host economy – some of their points include:
(1) Welfare costs: Increasing cost of providing public services as migrants come into a country.
(2) Worker displacement: Possible displacement effects of domestic workers – in crude terms this is
the argument that migrants take the jobs of workers in the host country. Anti-immigration
lobbyists have highlighted the correlation between immigration and high youth unemployment
in the UK economy
(3) Wage cuts: By increasing the size of the total available labour supply, migrant workers may
lower the wages of people in other jobs.
(4) Social pressures: Social tensions arising from the problems of integrating hundreds of thousands
of extra workers into local areas and regions.
(5) Pressure on property prices: Rising demand for housing which forces up prices and rents.
(6) Poverty risk: Migration may have the effect of worsening the level of relative poverty in a
society. And many migrant workers have complained of exploitation by businesses that have
monopsony power in a local labour market.
The benefits and costs of labour migration are hard to quantify and estimate. Much depends on
• The types of people who choose to migrate from one country to another.
• The ease with which they assimilate into a new country and whether they find regular jobs.
• Whether a rise in labour migration stimulates capital spending by firms and by government.
• Whether workers who come into a country decide to stay in the longer term or whether they
regard migration as essentially a temporary exercise (e.g. to gain qualifications, learn some
English) before moving back to their country of origin.
Recent empirical evidence from a variety of academic sources finds that the net effects of inward migration
to the British economy have been broadly positive but perhaps not as large as many expected.
• The effect on the UK’s trend growth rate has been small
• There has been little negative effect on average wages and unemployment among native workers
• The net impact on government finances has been positive; the UCL research finds that in the year to
April 2009 workers from eastern Europe paid £1.37 in taxes for every £1 of services they used
The EU Financial Crisis and Outward Migration from the PIIGS Countries
High unemployment especially among the young and falling real living standards brought about by higher
taxes, lower government spending and falling wages has prompted a rise in the levels of net outward
migration from many struggling EU countries in 2010 and 2011. A report in the Guardian in December 2011
found that “Tens of thousands of Portuguese, Greek and Irish people have left their homelands this year,
many heading for the southern hemisphere. Anecdotal evidence points to the same happening in Spain and
Italy.”

28. 28
13) Unemployment in the European Union
The European Union has struggled to bring down unemployment on a sustained basis for nearly twenty
years. Many EU countries have persistently high jobless rates and the problem has deepened because of
recession. But much of the unemployment in Europe is structural rather than cyclical. Our chart below
tracks unemployment rates in the Euro Area and three members of the currency union – Greece, Spain and
Ireland. All three of these countries have suffered a steep increase in unemployment rates with Spain
experiencing the worst unemployment rates and a deep problem facing younger workers.
In the autumn of 2011 the scale of the unemployment problem in the EU was as follows:
 The EU271 unemployment rate was 9.8% in October 2011 - it was 9.6% in October 2010
 23.554 million men and women in the EU27 were unemployed in October 2011.Compared with
October 2010, unemployment rose by 440 000 in the EU27 the majority of which came in the 17
nations of the Euro Zone
 Lowest unemployment rates were in Austria (4.1%), Luxembourg (4.7%) and the Netherlands (4.8%)
 Highest unemployment rates were highest in Spain (22.8%), Greece (18.3%) and Latvia (16.2%)
 In October 2011, 5.482 million young persons (under-25s) were unemployed in the EU27 and the
youth unemployment rate was 22.0% in the EU27. The highest youth unemployment rates were in
Spain (48.9%) and Greece (45.1% in August 2011).
Percentage of the labour force, seasonally adjusted
Unemployment in Euro Zone, Greece, Spain and Ireland
Source: Reuters EcoWin
Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep
06 07 08 09 10 11
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
20.0
22.0
Percent
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
20.0
22.0
Euro Area
Ireland
Greece
Spain

29. 29
Our chart above shows the effect of a deep recession in the Euro Zone on the rate of unemployment. Real
GDP fell by more than 4% in 2009 and the unemployment rate climbed from 7.6% in 2009 to over 10% in
2010 – mass unemployment returned to the single currency areas and this brings with it many economic,
social and fiscal costs.
Much of the unemployment in Europe is structural in nature – i.e. it results from problems on the supply-
side of the labour market not least difficulties in matching jobless people with the skills required in industries
that are taking on more employees. The natural rate of unemployment is based on an estimate of frictional
and structural unemployment – high natural rates of unemployment in Europe have many causes including:
1. Geographical and occupational immobility of labour
2. Employment laws that may raise the cost of employing extra workers especially among small to
medium size enterprises
3. Disincentives to look for and take work built into the tax and benefit systems i.e. possible
unemployment and poverty traps
Many regions in Europe suffer from chronically higher rates of unemployment and some of them have done
so for decades. In Europe’s 271 regions, 28 had an unemployment rate of 4.4% or less in 2009 but thirteen
regions had a rate of 17.8% or higher - double that of the EU27 average. Europe’s regional policies have a
key aim of stimulating enterprise, investment, jobs and incomes in these poorer regions. In the period from
2007 to 2013, regional spending accounts for 36% of the EU budget although many have pressed for more –
paid for by reforms to the CAP. The 12 countries which have joined since 2004 receive 51% of total regional
spending between 2007 and 2013 including help in funding investment in environmental and transport
infrastructure projects.
Left hand scale: Real GDP growth Right hand scale: Unemployment rate (%)
Euro Zone Growth and Unemployment Rates
Euro Zone, Real GDP, precentage change from previous period, Constant Prices
Euro Zone, Standardised unemployment ratesa, per cent of labour force, SA
Source: OECD World Economic Outlook and Euro Stat
03 04 05 06 07 08 09 10 11
Unemploymentrate(%oflabourforce)
7.0
7.5
8.0
8.5
9.0
9.5
10.0
10.5
11.0
11.5
RealGDPgrowth(annual%change)
-5
-4
-3
-2
-1
0
1
2
3
4

30. 30
14) Policies addressing Income Inequalities in the EU
The European Union consists of twenty seven nations with widely differing levels of per capita incomes -
even when adjusted for differences in the cost of living. And there are huge differences in incomes per head,
median earnings and employment rates within the regions of the EU. Income inequality can be measured in
various ways and one of these is the Gini coefficient.
Some economists claim that income and wealth inequality within the EU has increased over the last decade
or so. The forces of globalisation have certainly put pressure on real wages and job prospects in many
regions of Europe where productivity is relatively low and competitive advantages are thin on the ground.
Data from Euro Stat showed that in 2010, over 100 million people in Europe were at-risk-of poverty or
exclusion (23% of the EU’s total population).
The recession and financial crisis has worsened relative poverty within Europe and the issue has become
more important as public support for European institutions has dropped sharply. The EU unemployment rate
now stands at about 10%, up from 7% in 2008, and the risk of persistent long-term unemployment, poverty
and social exclusion will remain high for some time to come. Many people in Europe are worried about the
growing gap between rich and poor and are looking to national governments to intensify their efforts to
lower poverty rates.
What are the main policies to reducing income inequalities within the EU? Several strands can be identified:
(1) Policies designed to raise productivity levels - because this should allow wages to rise with
productivity to give workers an equitable share in economic growth
(2) Welfare policies providing sufficient income transfers for the poorest families - for example,
state pensions, unemployment benefit and sickness benefits. Some European governments
allow these benefits to rise with the annual growth in per capita incomes. Others link benefit
levels to changes in consumer prices which risks causing the relative value of benefits to fall
(3) Minimum wage legislation - at present there is no harmonised minimum wage policy across
Europe. Member countries are free to set their own pay floors or not to have one at all.
Minimum wage rates differ quite a lot across EU nations
(4) Changing the structure of taxation - this provides a key method of reducing the gap between
highest and lowest income families. Progressive taxation — taxes that take a bigger share of the
income of rich families than poor families — tend to reduce income inequality and some EU
countries have chosen to introduce high marginal tax rates for top earners and also make
stronger use of means-tested welfare benefits.
(5) Macroeconomic stimulus policies: The biggest cause of poverty is unemployment so the
effectiveness of economic stimulus policies in maintaining demand and jobs will be crucial in
providing people with the opportunity to earn extra income. Most EU governments have
introduced fiscal stimulus measures since 2008 but their freedom to do this is limited by high
levels of government debt and the rising cost of servicing the interest payments on borrowing.
The European Central Bank has cut interest rates to 1 per cent but has not many more options to
expand demand other than quantitative easing and perhaps an attempt to drive down the
external value of the Euro.
Ultimately Europe as a region needs to find new sources of growth driven by innovation and enterprise.

31. 31
Minimum Wage Rates in the European Union
The table below tracks minimum wage rates across most EU countries. The best way of ranking the relative
generosity of the pay floor is to adjust for differences in living costs and express at purchasing power
standard. A familiar picture emerges; minimum wages are substantially lower in Europe’s newer member
states where average wages are lower – notably Romania and Bulgaria.
Minimum Wage Euros per
month for full time workers
PPS Adjusted Value of the
Minimum Wage (Euros per
month for full time workers)
Hourly labour costs Euros
per hour in 2007
2004 2009 2009
Luxembourg 1,403 1,642 1,413 33.00
Netherlands 1,265 1,382 1,336 27.41
Belgium 1,186 1,388 1,254 32.68
France 1,113 1,321 1,189 25.25
United Kingdom 1,084 1,010 1,154 27.19
Ireland 1,073 1,462 1,153 Not available
Malta 541 635 810 8.69
Spain 537 728 760 16.39
Slovenia 471 589 710 12.09
Portugal 426 525 606 11.32
Poland 177 281 468 6.78
Czech Republic 207 306 443 7.88
Slovakia 148 296 409 6.41
Hungary 200 270 408 7.13
Estonia 159 278 362 6.60
Lithuania 125 232 347 5.09
Latvia 121 254 343 5.42
Romania 69 153 263 3.41
Bulgaria 61 123 240 1.89
Material deprivation – an alternative perspective on poverty
Inequality and poverty is not simply a reflection of low incomes. The causes and experience of poverty is
complex and many communities and regions have suffered from deep-rooted poverty for many years.
The EU now measures material deprivation as a broader measure of people at-risk of poverty. According to
recent figures in the EU27 in 2009, 42 million (or 8% of the population) were severely materially deprived,
meaning that they had living conditions constrained by a lack of resources such as not being able to afford to
pay their bills, keep their home adequately warm, own a car or a telephone etc.
The shares of those materially deprived varied significantly among Member States, with the highest in
Bulgaria (41%) and Romania (33%), and the lowest in Luxembourg, Sweden, the Netherlands, Denmark and
Spain (all less than 3%).

32. 32
15) EU Competition Policy
The aim of competition policy is to promote competition; make markets work better and contribute towards
improved efficiency in individual markets and enhanced competitiveness of UK businesses within the
European Union single market. Competition policy aims to ensure
 Wider consumer choice and improved service
 Technological innovation
 Effective price competition between suppliers
If these can be achieved then gains can be made in allocative, productive and dynamic efficiency
The main jobs of competition policy
1. Antitrust & cartels: This involves the elimination of agreements that seek to restrict competition
including price-fixing and other abuses by firms who hold a dominant market position (defined
as having a market share in excess of forty per cent).
2. Market liberalisation: Liberalisation involves introducing competition in previously monopolistic
sectors such as energy supply, postal services, telecommunications and air transport.
3. State aid control: Competition policy analyses examples of state aid measures to ensure that
such measures do not distort competition in the Single Market
4. Merger control: This involves the investigation of mergers and take-overs between firms (e.g. a
merger between two large groups which would result in their dominating the market).
The Role of the Regulator
The EU Competition Commission is a regulator of business activity in the single market. Key roles are:
1. Monitoring and regulating prices: Regulators aim to ensure that companies do not exploit
monopoly or oligopoly / duopoly power by charging excessive prices. They look at evidence of
pricing behaviour and also the rates of return on capital employed to see if there is evidence of
‘profiteering.’ Recently the EU Competition Commission made a ruling on the ‘roaming’ charges
of mobile phone operators in the EU and enforced a new maximum price on such charges.
2. Standards of customer service: Companies that fail to meet specified service standards can be
fined or have their franchise / licence taken away. The regulator may also require that
unprofitable services are maintained in the wider public interest e.g. BT keeping phone booths
open in rural areas and inner cities; the Royal Mail is still required by law to provide a uniform
delivery service at least once a day to all postal addresses in the UK
3. Opening up markets: The aim here is to encourage competition by removing or lowering
barriers to entry. This might be achieved by forcing the dominant firm in the industry to allow
others to use its infrastructure network. A key task for the regulator is to fix a fair access price
for firms wanting to use the existing infrastructure. Fair both to the existing firms and also
potential challengers. Opening up markets means making them more contestable.
4. The surrogate competitor: Regulation can act as a form of surrogate competition – attempting
to ensure that prices, profits and service quality are similar to what might be achieved in
competitive markets.

33. 33
In a nut-shell the role of competition authorities around the world including the European Union is to
protect the public interest, particularly against firms abusing their dominant positions - A firm holds a
dominant position if its power enables it to operate within the market without taking account of the reaction
of its competitors or of intermediate or final consumers.
Case study: EU competition commission enforces price cap on mobile phone charges
The EU Competition Commission has enforced a price cap on the cost of sending text messages when abroad and has
introduced a maximum charge for receiving and making a phone call. At a time when both external and internal
economies of scale were lowering the unit costs of domestic phone calls, international roaming charges remained high
and the Commission decided there was an exploitation of monopoly power.
The Commission has had to balance the desire for competition with the need to avoid over-regulation. Vodafone made
a pre-emptive strike ahead of the likely regulation in roaming charges, by saying it would cut the cost of using other
companies’ networks when abroad by at least 40 per cent; it has since announced an end to roaming charges.
Under the new limits there is a single tariff covering all 27 EU member states - bringing the maximum charge for making
a call while abroad down to 37p per minute. Receiving calls now costs a maximum of 17p per minute. Sending a text
message from another country inside the EU will cost no more than 10p. Data transfer prices have also fallen, with one
megabyte of data now costing 85p.
Investigating collusive behaviour
In recent years the EU Competition Commission has been active in investigating allegations of price fixing
and market sharing. Here are some recent examples to explore:
 Commission imposes € 8.9 million fine in banana cartel (October 2011)
 South Korean and Taiwan TV screen firms fined by EU for price cartel (December 2010)
 Euro800m fine for airline cargo cartel (November 2010)
 EU investigates Google's dominance in search (November 2010)
 EU fines bathroom cartel 622m Euros (June 2010)
 Chipmakers fined by EU for price-fixing (May 2010)
 EU cartel fine for plastics firms (November 2009)
Legal Collusion – Horizontal Cooperation
Not all collusive behaviour is deemed to be illegal. Practices are not prohibited if the respective agreements
"contribute to improving the production or distribution of goods or to promoting technical progress in a
market” - for example:
 Development of improved industry standards of production and safety which benefit the consumer
– a good recent example is joint industry standards in Europe for mobile phone chargers
 Information sharing designed to give better information to consumers
 Research joint-ventures and know-how agreements which seek to promote innovative and
inventive behaviour in a market. The EU has introduced a “R&D Block Exemption Regulation” for this
In December 2010 the EU Competition Commission introduced new guidelines on the types of
‘horizontal cooperation’ that is allowed under EU laws.

34. 34
16) EU Farm Policy and Reform
“European Union farm subsidies were paid out last year to Swedish accordion musicians, Danish snooker players, Dutch
ice skaters and an Estonian society for old school classmates, official figures show.” (Source: www.farmsubsidy.org)
In this section we review the arguments surrounding the farm policies of the European Union.
• The CAP is a complex system of farm support and has been a highly contentious issue for many years
• Some believe that it has been one of the EU’s most successful policies
o Farm payments give farmers security, predictability and a planning period to encourage
investment. Many farms would simply not be viable without some form of subsidy
o Subsidies are needed as a transfer of income to relatively low-income regions. Average
income in farming is substantially lower than that in the rest of most EU countries
• Others regard the CAP as a waste of money with huge economic, social and environmental costs
• The CAP accounts for nearly half the EU budget – it cost 58bn Euros (£51bn) last year - 47% of the
whole EU budget - and it is the world’s most generous system of agriculture subsidies
• The CAP is the biggest budget item - 47% of total in 2010 – average subsidy per farm: 12,200 Euros.
If the pound falls against the Euro, this increases the value to British farmers of CAP payments.
• 20% of CAP funds go to France; the UK gets 9% of total EU farm support. France, Spain, Germany and
Italy together get 60% of EU farm subsidy money
• New EU member states such as Poland and Latvia began receiving CAP subsidies in 2004, but at only
25% of the rate they are paid to the older member states. These countries are lobbying for further
reforms of the CAP to make it fairer to relatively poorer countries
• There have been many attempts at reform over the years - reforming the CAP is crucial and
controversial in terms of EU’s trading relationships with many developing countries

35. 35
Criticisms of the EU System of Farm Support
(1) Production inefficiency and surplus: In the early years of the CAP, generous intervention prices
led to huge surpluses and a misallocation of scarce resources damaging consumer welfare.
(2) An absence of innovation in farming: Some economists argue that direct payments to farmers
act as a brake on innovation. Innovative marketing and product development in sectors de-
coupled from direct price support such as pigs, poultry, potatoes and most fruits and vegetables
has been at higher levels than in more heavily-supported products
(3) Industrial farming: The CAP has encouraged big business ‘factory farming’ or ‘industrial farming’
has led to problems with food safety and animal welfare and has contributed to deforestation
within Europe and increasing reliance on imports of cheap soya
(4) Opportunity cost: Farm subsidies could have been better spent elsewhere e.g. on healthcare,
transport infrastructure or investment in green energies
(5) Fraud: For many years there have been accusations of corruption and fraud in the running of the
CAP. Many subsidies go to farmers who are no longer producing – known as “sofa farmers”. The
complexity of the system of farm support has also made it expensive to operate
(6) Environmental impact: There is plenty of evidence of long-term damage to the environment as
farmers searched for higher production yields in pursuit of farm subsidies.
(7) Consumer welfare has been hit by higher food prices (trade diversion) leading to a sharply
regressive effect on lower income families where food is a higher % of total spending. Paying for
the CAP costs the average British family of four some £426 a year.
(8) Impact on developing countries: The CAP is alleged to have caused severe damage to the food
export industries of many LDCs – e.g. the dumping of EU food surpluses in their markets helped
by EU export subsidies. Africa accounts for less of the total trade in the world today than it did in
1990, mostly because of its inability to export produce due to subsidies to farmers in Europe
(9) Inequitable distribution of subsidy payments:
 Many farm support programmes benefit larger scale wealthier farmers most. Europe’s
biggest landowners have reaped the highest CAP payments. The Duke of Westminster,
for instance, received a reported £5.8m pounds over the 10 years to 2009.
 The CAP since the enlargement of the EU in 2004 offers inequitable payments to
farmers. According to a recent report, while Greek farmers reap an average of €560 per
hectare, those in Latvia get less than €90. Polish farmers get less than €200 per hectare.
 The CAP system channels money into the highly mechanised industrial farms on the
most productive land such as the Paris Basin and East Anglia and Lincolnshire. But many
UK farmers remain poor despite the CAP. The poorest 25% of farms have income of less
than £20,000 a year, and a third of those failed to make a profit over the past three
years, according to a 2010 report from the Commission for Rural Communities
 The biggest CAP beneficiaries in 2009 were large sugar companies!
Put these criticisms together and the CAP is claimed to be a deep example of government failure leading to
an inefficient and inequitable allocation of scarce resources and much higher prices for consumers. But the
political interests of farming businesses and agricultural lobbyists in many EU countries have prevented full
scale reform to what is a discredited system of farm support.

36. 36
Analysis: Intervention prices and food surpluses
This is one of the analysis diagrams that might be used to show the impact of a high market intervention
price on food supply.
Setting a high common target price for certain foodstuffs benefits producers who have exploited economies
of scale and brought down the marginal and average cost of supplying food. This is shown in the diagram
below. At a given intervention price, the producer surplus accruing to the small-scale farmer is area A
whereas the producer surplus flowing to the large scale farmer is area A + B + C.
But higher prices come at a cost – to consumers. Paying prices, which are significantly above world prices,
means a loss of consumer surplus among EU citizens.

37. 37
Attempts to Reform the Common
Agricultural Policy
Farmers lobbying against CAP reforms at a
meeting of the EU Commission in Luxembourg in
2009
For decades politicians have struggled
to reach agreement on reforming the
CAP. The biggest stumbling-block are
the deep vested interests of countries
(and their farmers) who benefit most
from the system of CAP support – most
notably the French who are the largest
beneficiaries of the CAP system.
Some of the major reforms in recent years are mentioned below:
(1) Set-aside: Designed initially to reduce surpluses and protect the environment – payments were
made to farmers to leave their land fallow and not grow food. Environmentalists welcomed this
reform because it helped to protect biodiversity in rural areas. Set aside was temporarily
suspended during 2007-08 in the wake of super-high world food prices. The new reforms aim for
European farmers leaving 7% of their land fallow
(2) Decoupling: A single farm payment independent from production means that farm incomes are
no longer dependent on how much food is supplied. This has helped to cut food surpluses and
reduced the amount of European food dumped on the markets of poorer developing countries.

38. 38
But there is evidence that the bulk of farm payments flow to larger land-owners many of whom
no longer farm but who rent out their land to tenants who receive no farm support.
(3) Reductions in guaranteed prices (e.g. a recent 36% cut in guaranteed price for sugar) and an
end to intervention buffer-stock schemes for products such as butter
(4) Caps on maximum farm payments – October 2011 reform announcements plan capping the
total subsidy a large farm can receive at 300,000 Euros
(5) Environmental husbandry payments: Farm income payments conditional on EU farmers
meeting agreed standards of environmental care, food safety & animal welfare (known as cross
compliance).
(6) Reduction in payments to bigger farms (known as “modulation” and “digression”) to help
transfer funds to EU rural development programmes
(7) Financial incentives to encourage farmers to switch towards organic farming
(8) A gradual move to allow food prices to be set by global forces of supply and demand.
Many countries subsidise their agricultural industries and few are prepared to allow free market forces to
operate as a way of setting prices and influencing production in farming markets. There is inherent price
volatility in international food prices and despite CAP support many farmers leave the industry each year
because they cannot operate profitably. Some of this has nothing to do with the CAP – for example the sharp
fall in milk production in the UK is blamed in part on the monopsony power of the supermarkets in driving
down the prices that milk producers get.
But there are potentially huge gains to be had from fundamental reform of the CAP and a reduction in farm
subsidies worldwide. The Organisation for Economic Co-operation and Development (OECD) has estimated
that cutting agricultural tariffs and subsidies by 50% would add an extra $26bn to world income.
Index of Prices 2000=100
The Economist Commodity Price Index
Commodity Price Index Food Commodity Price Index All Items
Source: Economist Commodity Price Index
06 07 08 09 10 11
100
125
150
175
200
225
250
Index
100
125
150
175
200
225
250
Industrial Metals
All Commodities
Index of Global Food Prices

39. 39
17) Environmental Issues and Policies in the EU
The European Commission is setting tougher limits on CO2 emissions to tackle climate change. This action by
the EC appears to signal a belief in making stronger use of the market mechanism and incentives to
encourage industry to confront the costs of environmental damage. But EU regulations / laws are also having
a direct effect on both producers and consumers. And many EU countries are prepared to introduce a wider
range of environmental taxes to achieve their long term carbon reduction targets.
Environment as a public good
• Environmental assets are quasi-public goods that are not usually exchanged on markets. Thus no
price emerges to signal relative scarcity and change consumer and producer behaviour
• The destruction of these endowments is inevitable and inexorable without effective intervention
• The key question is which combination of interventions is most effective in meeting specific
environmental challenges.
Europe faces a huge environmental challenge:
• Growing municipal and industrial waste
• Contribution of EU countries to global warming / climate change
• Protecting nature and minimising the loss of biodiversity
• Rising congestion, noise and air pollution
• Water shortages and water quality
• Natural resource depletion – preventing the tragedy of the commons
EU Targets:
• 20% cut in greenhouse gas emissions by 2020, compared with 1990 levels
• 20% increase in use of renewable energy by 2020
• 20% cut in energy consumption through improved efficiency by 2020
Main Environmental Strategies
1. “Making the polluter pay” taxes to change relative prices to change incentives
2. Raft of EU directives / regulations on environmental issues including end of life
directives for durables such as cars, washing machines and televisions
i. Max C02 emissions per km for new cars
ii. Water quality and safety, minimum waste recycling targets
i. Promoting renewable energy sources
3. Promoting investment in carbon capture and carbon neutralisation schemes
4. Development of carbon trading in Europe as a market based mechanism
5. Application of the precautionary principle i.e. the principle that action/intervention
should be taken to prevent harm to the environment before full evidence is available.
6. A degree of fiscal harmonisation within Europe to achieve some environmental goals
7. Improving the flow of information to consumers about the carbon impact of their
purchases and use of different products

40. 40
Carbon Trading
(1) The EU Emissions Trading Scheme (EUETS) was launched in January 2005 and is a market-based
mechanism to incentivise reduction of C02 emissions in a cost-effective and efficient manner.
(2) The EU scheme operates through the allocation and trade of CO2 emissions allowances. It
creates a market in the right to emit C02. One allowance represents one tonne of C02
equivalent. Companies get most permits free now but many electricity generators in Europe will
have to pay for all these from 2013.
(3) A cap is set on emissions – this creates the scarcity required for the market. At the end of each
year businesses are required to ensure they have enough allowances to account for their
installation’s actual emissions. There are heavy fines for those without such permits.
(4) The aim of carbon trading is to create a market in pollution permits and put a price on carbon.
In this way, policy can help internalize environmental costs of firms’ production and encourage
lower emissions to tackle climate change
(5) In a cap and trade system, the number of available permits would gradually decline. As the price
of the permits rises, so the economics of investing in cleaner technologies will change. The hope
is that businesses will look for ways of reducing c02 emissions in the most efficient way possible.
a. Assets: If a carbon emitting business can under-use its initial allowance by better energy
efficiency, it can sell its surplus on the market.
b. Liabilities: If a business is faced by high costs to reduce its emissions, it must buy extra
allowances
Supply and demand analysis diagrams can be used when discussing carbon trading schemes. The idea is to gradually cut
the supply of permits so that the carbon price is sufficiently high to incentivise businesses to look for ways to cut their
total emissions in the most cost-efficient way.
EU Carbon Trading Market in TheoryPermit Price (Euro per tonne of C02)
Quantity of Permits
Supply
2010
Supply
2012
Demand
2010
Demand
2012Price
2010
Price
2012
Cap
2010
Cap
2012

41. 41
Weaknesses of the EU carbon-trading scheme
“In 2008, (Phase II 2008-2012), the EU carbon price peaked at almost €30 per tonne CO2 (t/CO2) (£26/tCO2).
Following the global financial crisis and subsequent economic recession, the price then fell below €10/tCO2
(£9/tCO2) in the first quarter of 2009. Over the past 12 months, the carbon price has fluctuated between €12-
16/tCO2 (£10-14/tCO2).” (Source: UK Treasury Report, December 2010)
(1) The EU system has suffered from government failure because of the over-allocation of carbon
quotas and national freedom to allocate carbon permits. Allowances were handed out for free
rather than being auctioned off
(2) In recent times (partly because of the European recession), the carbon price collapsed with the
effect of driving up the demand for coal fired energy! – A dirtier fuel! (This is another example of
the law of unintended consequences)
(3) When carbon prices are low and uncertain, there is less incentive for companies to stop
polluting and there are fears for the future of many clean-energy projects that necessarily have
long lead-times. Some economists have called for a minimum price to be applied to the carbon
market. The new UK coalition government has committed itself to introduce a floor price for
carbon and is considering supporting this with additional carbon taxes.
The volume of carbon permits traded has grown but prices have been low in both phases
“Given the lead times involved between the decision to invest and the plant generating electricity (for
example, around 8 years for nuclear, around 2-3 years for offshore wind and 4-5 years for carbon capture
and storage), there is a need to influence investment decisions being taken over the next few years.”
(Source: Treasury Report, 2010)

42. 42
Carbon offsetting
Most emissions trading schemes offer trade in carbon offsets, or carbon credits. This allows emitters to pay
someone else outside the scheme to cut their emissions instead. If it is cheaper to pay someone in China to
plant a forest to absorb carbon dioxide, or a factory in India to install clean technology to cut its emissions of
greenhouse gases, then doing so will generate carbon credits equal to one tonne of emissions saved. These
credits count towards the emitter’s target back home. The use of offsets is usually controlled because some
businesses may choose to use this as a way of buying their way out of their carbon-reduction obligations.
Other carbon trading schemes have been introduced outside of the European Union – here are brief details:
1. New Zealand emissions trading scheme (launched July 2010): Covers: Forestry, electricity, industrial
process emissions and transport. Waste to start in 2013 and agriculture to start 2015.
2. Japan: Tokyo metropolitan trading scheme (launched April 2010): Covers: Around 1,400 top
emitters. Tokyo city sets emissions limits for large factories. Bi-lateral offsets scheme promotes
emissions reduction projects in developing countries. This is Asia’s first emissions trading scheme.
3. Californian climate change law (Launch: Law passed in 2006; carbon trade to launch 2012): Covers:
Economy-wide emissions, from power plants, manufacturing and, in 2015, transportation fuels.
4. South Korea emissions trading scheme (Launch: Phase 1 runs from 2013-2015): Covers: About 470
companies or operations that emit more than 25,000 tonnes of carbon dioxide annually and are
collectively responsible for 60 percent of the country's emissions
5. India: Perform, Achieve and Trade system (Launch: April, 2011 with trading from 2014: A
mandatory energy efficiency trading scheme covering more than 700 companies in nine sectors
responsible for 65 percent of India's industrial energy consumption.
An alternative or a complement to trading: The economics of carbon taxation
A carbon tax is a tax on the consumption or production of goods and services, which cause carbon emissions
The case for a carbon tax:
• A tax creates specific price on carbon – with less uncertainty than emissions-trading
• It is a classic way of internalizing externalities (i.e. making the polluter pay) - the tax would raise the
marginal cost of the cO2-emitting activities, up to the point that the marginal social cost of
abatement activities is equated to the marginal social benefit from these activities
• Provides an incentive for firms to lower emissions and for consumer behaviour to change
• The tax can be phased in and can be revenue neutral (i.e. other taxes can be cut)
• Revenue generated can be “ring-fenced” and then recycled – i.e. spent on environmental initiatives
Counter arguments:
• Issues of who to tax and how much to tax when emissions are difficult to measure / quantify
• Potentially high costs of compliance (administration) and the risk of tax evasion
• Possible regressive effects on low-income families (when carbon taxes are passed on in prices)
• Less certainty about the effect on quantity of emissions than a trading scheme
• Non EU-countries may free ride i.e. enjoy a reduction in emissions without imposing their own tax
• Would potentially damage competitiveness and jobs of EU countries
• Would politicians be prepared to raise the carbon tax sufficiently high to reduce emissions?