13/10/2010 EUROPEAN ECONOMICS: LECTURE 1 TRADE INTEGRATION Quick-Points May/June 1945 signified the end of WW2.

. Key figures in European politics said never again. They looked at key causes of WW2, identifying in turn the key things that needed to change. Suggested Solutions Place the industries that contribute to war effort beyond the control of national government, in such a way that would prevent another arms race between the two main warring countries, Germany and France (who had been at war with each other three times in less than 100 years) Encourage trade integration. o It was noticed that countries that were trade-integrated did not go to war with each other, because they were dependent on each other. There is no particular incentive to go to war. o Trade integration fosters specialisation in products o Remove trade barriers: Tariffs Import quotas Levies Non-tariff barriers Encourage monetary stability o Different currencies mean that trade happens through an exchange rate. This exchange rate affected the flow of trades. o At the time there was exchange rate volatility trade integration cannot work in this context. Businesses unwilling to have foreign business contracts because of the uncertainty of the exchange rate. They will thus prefer domestic suppliers, even if quality is lower, price is higher etc. A very powerful barrier to trade. Prevent the use of the exchange rate as a competitive policy o In the inter-war years, due to the animosity of WW1 being fresh in countries minds, they would engage in commercial wars. For example, competitive devaluation (beggar thy neighbour) of their currencies. These were non-alturistic policies that affected the exchange rate. o These commercial wars would aim to gain a competitive advantage over competitors. o Leads to retaliation between countries, including the introduction of trade barriers. o The experience of the 1920s was that commercial wars preceeded the actual military wars. Europe needed to create an environment that fostered trade integration and achieved union, preventing another war. The Treaty of Rome, 1956 Created a variety of communities (such as a coal and steel community) that were placed under control of a supra-national authority, in order to prevent an arms race. Create a union whereby trade barriers abolished. Establish free movement of goods as a principle (ideally also labour, but this happened much later in the 1980s where the common market established free movement of FOP)

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One clause stipulated that members (few members at the beginning) were going to treat bilateral exchange rates as a matter of common concern, with an intention to develop trade integration. (Soviet) vs West Europe The distrust between Western Allies towards the Soviet Union was notorious. Stalin, the Soviet dictator, was very concerned about Americas nuclear power and was afraid that the next stage would be for the UK and USA to try and bring the Soviet Union to an end and re-establish some form of nonsocialist government. He was therefore keen for there to be a sort of buffer zone that would prevent any invading army. o The iron curtain in particular it cast Germany into two zones Eastern and Western. This later assumed a physical form the Berlin Wall (construction started 1961) o This Economic and Political confrontation is important. The Western side was seen in favour with the US, because the US was providing key aid (Marshall Plan) to Western European nations. o It saw the success and reconstruction of Western Europe, along the lines of free market democracies, as essential in the fight against the power of the Soviet Union. This was an ideological confrontation, not a physical confrontation. They wanted to show them that the Western system was better. o It provided the leadership for monetary stability (stable exchange rate).

Bretton Woods (1944), USA Established a version of the Gold Exchange Standard (which had prevailed before WW1) Designed to ensure monetary stability across the world. It was also in the USs interest for there to be exchange rate stability to export its produce and find markets abroad. Each currency had parity to the dollar and the dollar was convertible to gold (which had a parity declared to gold) It was considered a fixed but adjustable exchange rate since some band of fluctuation allowed (a return to the original Gold Standard, where exchange rates were fixed, was considered a bad idea) about the fixed parity. Countries agreed to have a narrow the band of fluctuation, to reduce the risk of exchange rate volatility (which depressed trade). The Collapse of the Bretton Woods System Cold War being fought outside Europe, in particular the confrontation between North and South Vietnam. The US supported the South, funding its war effort by money creation (selling bonds, i.e. issuing more dollars). o Creates a problem, since the dollar is supposed to be convertible into gold. It is the anchor currency, the system (i.e. all other currencies) is anchored to the dollar and the dollar is anchored to gold. The more dollars in circulation, the more people will think that the gold in Fort Knox will begin to run out. This triggers fears that gold will run out, so much so that Charles de Gaulle (French president) starts requesting gold. o Creates turmoil - we start doubting US commitment to monetary stability. 1970s Western world hit by oil price shocks (Eastern socialist countries less hit) o Has the West got it all wrong? Everything is collapsing in the West. US makes a retreat from Vietnam. o Doubts about the gold convertibility of the dollar. The US decides to suspend all convertibility of the dollar, thereby bringing to an end the Bretton Woods system.

13/10/2010 US secretary of state stated Dollar is our currency, but it is your problem As a consequence, the dollar is not worth what is used to be. Investors flee to safety to a currency that has become very stable and committed to stable currency (in this case, the Deutschmark) o The Deutschmark, following the terrible hyperinflation of the 1920s, is fully committed to maintaining a stable currency and price stability. o The Quest for Monetary Stability article Many countries already experiencing high inflation. If their currencies devalued, it would be negative for the Germans too because their growth is based on the possibility to export. So the concept of the ERM comes into play. o

The Exchange Rate Mechanism Provided an excellent solution for the 1980s. o Economic growth rates excellent. o Further economic integration. Completion of single markets, establishment of key principles of freedom of movement of capital and labour. Became a model for the rest of the world, in particular Eastern Europe and East Germans (because East Germans can see West German television). 19th November 1989: Collapse of the Berlin Wall. Within a year Germany is reunited. Transition Economies Socialist command economy market economy Characteristics of socialist economies: o Everything centralised (GOSPLAN in Moscow) with a central planning authority, which works out a matrix of inputs and outputs for production and prices across the entire country. o Bottlenecks o Asymmetries of information, exploited by factor managers. Approach taken by the different countries is very different! Some go for the big bang, others take it slowly. Accession to the European Union Britain o In the 1960s Britain decides it needs to join the EU. This is refused by Charles de Gaulle. o However, Britain finally joined in 1974. o It remained largely uninvolved however, refusing to join the monetary solution.