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Going beyond the Single Market: Why Europe must become a Single Economic Territory (SET)

Single market / COMMENTARY
Fabian Zuleeg

Date: 10/07/2020
The COVID-19 crisis has triggered unprecedented government interventions across the EU, thereby exposing the pre-existing limitations of the Single Market. To avoid further internal divergence, the Single Market must upgrade to a Single Economic Territory that incorporates a common microeconomic approach.

Despite Jacques Delors famously declaring that you cannot fall in love with the single European market, it has been a cornerstone of the European integration process. At times, it has been the crucial glue keeping the member states engaged, even in difficult times. With this in mind, it almost seems sacrilegious to call for the EU to move beyond the Single Market (SM).

Yet, the EU should do so by establishing a Single Economic Territory (SET).

The concept is related to, but not synonymous with, the ‘Genuine Economic and Monetary Union’ (GEMU) that moved into focus during the ‘euro area crisis’. Back then, at least within the eurozone, the shift to GEMU – including more integrated economic governance and a Banking Union, which would complement the common market, customs union and monetary union – was seen as the necessary integration step to manage and eventually overcome the crisis. It also intended to future-proof the existing Economic and Monetary Union (EMU) against potential economic crises yet to come, particularly the kind of sovereign debt crisis witnessed during the past decade.

It is now time to apply the same logic to the SM within the context of the COVID-19 crisis. The new crisis has changed the framework conditions under which the common market operates. It is thus time to update the existing policy approach to the SM to make it future-proof. Addressing the ongoing global structural economic shift requires creating a substantive common microeconomic and sectoral policy framework to accompany the four freedoms, going beyond state aid and competition policy.

The successes and limitations of the Single Market

The SM has been based on the provisions of the European Treaties, which stipulate an internal market characterised by the abolition of obstacles to the free movement of goods, persons, services and capital, embedded in a wider framework of a customs union, common competition and commercial policy, horizontal and sectoral flanking policies, as well as policies to strengthen economic and social cohesion.

The overarching logic has been to remove barriers between member states while ensuring that there is a level playing field for European firms (e.g. by establishing the legal principle that firms from other EU countries must be treated equally to national actors) and an, admittedly limited, compensation mechanism for the potential losers of additional economic integration (e.g. the Delors I Package that accompanied the establishment of the SM in 1992). This approach has produced spectacular successes: substantially increased cross border flows and competition; trans-European supply chains; and the limited ability of EU countries to distort economic development through state intervention by, for example, using state aid to influence companies’ location decisions. The economic benefits of the SM amount to 8.5% of the EU’s GDP and 56 million European jobs depend on the trade within it.

However, this reactive approach based on prohibitions and overcoming barriers was already failing to deliver even pre-COVID-19, given the global challenge Europe was facing. It is no longer sufficient to strictly regulate the interaction of EU firms with each other, as they all increasingly compete with firms from all over the world, in a globalised market. It is not leading to the necessary digital and sustainability transformation, nor is it able to deal with the international dimension of the SM effectively in a world where multilateral global economic freedom is threatened, even before the COVID-19 crisis struck. The pandemic is, in many ways, an accelerator of pre-existing trends. Arguably, the pre-COVID-19 approach is even less able to deal with current geo-economic changes, nor the fundamental shift in market structures resulting from the pandemic.

A brave new world

Old recipes no longer work, because the pandemic and the response to COVID-19-related economic challenges are changing this world and its underlying economic structures. The state is back with a vengeance, including in the EU. State aid is dispersed at record levels, with the European Commission readily (and justifiably) dispensing exemptions from the normal competition rules. Governments are intervening in markets, including taking equity stakes in companies when they are being rescued, creating a long-term commitment and political obligation. In certain sectors, including health, the demands for reshoring production to within the EU are becoming hard to resist. At the global level, the ‘my country first’ narrative is gaining wider traction.

These developments are not necessarily driven by a wish for more protectionism, but can be based on understandable objectives that have gained importance during the current crisis: the need to increase (open) strategic autonomy and ensure the security of supply, the desire to rescue companies that would be (more than) viable in the absence of COVID-19, and/or the need to save as many jobs as possible. But these state interventions will inevitably have an effect.

The recent White Paper by the European Commission on foreign subsidies recognises that state aids (foreign or EU) can distort the SM. However, it stipulates that in relation to COVID-19-related state aid, “the current assessment framework is temporary and limited in scope to crisis measures.”

This underestimates the permanency of some of the current interventions, for example, when governments and their agencies take over the equity of certain companies. Furthermore, interventions inevitably differ from country to country, given the differences in capacity between member states. As such, the White Paper underestimates the sheer scale and distortive effects of interventions. The fact that one country, Germany, is currently providing around half of all state aid in the EU illustrates this risk starkly.

The market is not going to self-correct any time soon. This crisis is long-term and will continue to require strong state intervention, driven by economic, social and political rationales. The differential capacity to respond will, over time, have an even bigger impact, as the current economic crisis is characterised by cross-border excess capacity/supply. As demand in many sectors will not return to pre-crisis levels, consolidation and bankruptcies will be inevitable, with those companies strongly supported by their governments more likely to survive.

This implies that, over time, it will become increasingly difficult for a country to hold on to their companies if another is supporting their competitors proactively. The distortions of the level playing field are thus likely to become permanent.

Acting together

Given this (permanently) changed environment, what can, and should, the EU do?

One option would be to return to the pre-COVID-19 status quo. However, this is unlikely to happen. Politically, member states will not accept SM restrictions on, for example, state aid in a time of economic turmoil, when economic survival takes precedence over all other objectives. Returning to the status quo is also unlikely to be the optimal strategy in a world where others no longer strive to remove these distortions to competition from the international system.

However, resigning ourselves the post-COVID-19 economic status quo is equally unacceptable. It implies that divisions in economic development caused by the pandemic will become permanent, with many regions and countries left behind. While there might be greater hand-outs from the economically stronger member states, channelled through the EU via, for example, its Next Generation EU recovery instrument, they will not sufficiently balance out the distortions created by national interventions, nor incentivise the move towards greater sustainability and technological sovereignty. The result might well be a permanent division in economic performance, which will inevitably lead to political challenges. In short, pursuing this route might risk the future of European integration if it ultimately undermines one of its fundamental cornerstones: the Single Market.

The solution is to jointly define and implement common objectives, carrying out these interventions at the EU level. One obvious example would be state aid: a coordinated approach at the European level is the only consistent way to avoid distortions. The starting point should be an EU-wide industrial strategy which takes account of cross-border effects explicitly; as well as encapsulating the EU’s strategic objectives, including the digital and sustainability transformations. Any proposed member state intervention should be tested for its compatibility and consistency with such a strategy before considering an exemption to the usual SM rules. While this would not constrain member states in many instances (e.g. in goods and services that are not usually traded across borders), it would ensure that the EU is working towards common goals, not merely national interests, in areas where state aid has strategic implications.

Similarly, when dealing with third countries – including the US, China and the UK – there is a need for a common approach. Otherwise, how could the EU ensure a consistent line on state interventions and their trade-distorting effects, given that some EU member states are themselves intervening in their own economies heavily? Only a common EU approach encapsulated in an industrial strategy can ensure that the Union is not seen as simply reverting to national protectionist instincts.

Taking such a common approach would be in the interest of all member states. It would ensure that countries most affected by the economic implications of COVID-19 do not become permanently dependent on hand-outs and continue to compete and integrate within the SM instead. It would defuse the political dynamite that is being created by Germany’s capacity to support its industry, thus making the country’s approach more sustainable, both politically and economically. For countries like the Netherlands, Austria or Finland, supporting the creation of a SET should be of highest priority, given their dependence on free trade within the level playing field of the SM.

So, not only does the EU need a common macroeconomic framework as stipulated by the GEMU proposals (i.e. structural reform, fiscal and monetary policy), but also a microeconomic framework that includes proactive sectoral and microeconomic interventions. In the post-COVID-19 period, there is a need to go beyond the concept of the Single Market to create a Single Economic Territory that incorporates such a common microeconomic policy approach. This is the only way to ensure that internal divergence does not increase in light of unprecedented government interventions, ultimately threatening the European project.

Fabian Zuleeg is Chief Executive of the EPC.

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