An Abbreviated and Biased Timeline of the European Union

This is the first post in a series of how Britain leaving the EU might impact the financial services industry generally, and the fixed income and foreign currency markets in particular. To put the UK vote in context – we consider the rather laborious and at times contentious development of the EU, which evolved from a loosely defined trading area to a single market with a (mostly) common currency. Over the decades, the majority in several countries chose not to join the EU or EEA for reasons similar to why Britain has now chosen to leave it. In that respect, although the outcome of the vote may have been unexpected by the pollsters, it was hardly unprecedented.

Editorial aside: As an observer and citizen of a former British colony (hat tip to both King George and George Washington), it has at times been difficult to understand what all the elbow-throwing is about between the countries in the Europe. However, we fought a war to gain our sovereignty and lower our taxes (oh, the irony) so it’s understandable that significant net benefits should accrue from willingly ceding such power to a supra-sovereign organization. Let’s hope the new government – once elected - quickly puts a plan in place for ongoing relations with the EU and moves forward. There are two obvious options (e.g. the Norway model or Switzerland model) which we briefly touch on in this post, and have been discussed ad nauseum in the press. (Pardon for adding to the nausea.)

An Abbreviated and Biased Timeline of the European Union

1957: The European Economic Community (EEC) was created by the Treaty of Rome in order to facilitate an economic integration of its member states. This economic integration included a customs union and a common market. The six founding members of the EEC, often referred to as the “inner six”, were: Belgium, France, Italy, the Netherlands, Luxembourg and West Germany.

·         A customs union is a type of trading bloc with free trade between the members and a common external tariff. Customs unions alone generally only cover free trade of goods, and do not include free movement or trade of services, capital or labor (people) between members.

·         A common market is one where members have relatively free movement of capital and services, though significant non-tariff trade barriers may remain, e.g.  there may be differences in members safety, packaging and marketing standards. A common market can be considered a first step towards a single market.

As part of the common market, the Treaty of Rome also outlined objectives for a Common Agricultural Policy (CAP) and a Common Fisheries Policy (CFP). These policies would be drafted, adopted, come into force, be criticized, debated and reformed (many times) over the following years as the EEC, and later the EU, developed.

1960: Britain responded to the formation of the EEC in part by instigating the formation of a competitive organization, the European Free Trade Association (EFTA). The EFTA was established as a free trade area for European states who were either unable or unwilling to join the EEC. The seven founding members of the EFTA, often referred to as the “outer seven”, were: Austria, Denmark, Norway, Portugal, Sweden, Switzerland and the United Kingdom.

·         The EFTA does not have a customs union – so there is not a common external customs tariff - but it does coordinate trade policy among its members.

·         Members were also allowed to negotiate individual trade agreements with non-member countries.

1961: Denmark, Ireland, Norway and the United Kingdom apply for membership in the EEC. Their membership was rebuffed (vetoed, actually) by then-President of France Charles de Gualle, who feared that inclusion of the UK would function as a back door to US influence.

1962: Common Agricultural Policy The CAP, formally adopted in 1962, is a system of agricultural subsidies, price supports and farming programs.

·         CAP has been a primary source of conflict, both within and outside the EEC (now EU), since its inception. The cost of the CAP program represented 71% of the EU budget in 1984, The cost has declined, but still totals 39% of the EU budget as of 2013.

·         Currently only 5.4% of the EU’s population works on farms, and the farming sector contributes only 1.6% of EU GDP (as of 2005).

·         Among the many criticisms of CAP is that it allows outdated farming and production methods; contributed to artificially high food prices in the EU; encourages overproduction of some crops and products; results in quotas and waste; provides overly generous welfare to inefficient and unprofitable rural farms; is environmentally unfriendly, and increases poverty in developing economies.

·         Waves of CAP reforms have been proposed – and some adopted – over the years. The EU farming lobby is still powerful.

·         The CAP subsidies particularly irk more urban countries, such as the UK and Norway, who are net payers into the EU, and those like Sweden who believe all farm subsidies should be abolished.

1967: The four countries resubmit their applications for membership; in 1969 Georges Pompidou succeeds Charles de Gaulle as President of France and the veto is lifted.

1970: Common Fisheries Policy The CFP was created to manage fish stock for the EU as a whole, and maintains a system of quotas, regulates production and grading, sets minimum prices and buys up unsold fish, and sets trading rules for non-EU countries. The CFP almost immediately became a sticking point for the countries of northern Europe. Excerpted from Wikipedia, Common Fisheries Policy:

The first rules were created in 1970. The original six Common Market members realized that four countries applying to join the Common Market at that time (Britain, Ireland, Denmark including Greenland, and Norway) would control the richest fishing grounds in the world. The original six therefore drew up Council Regulation 2141/70 giving all Members equal access to all fishing waters, even though the Treaty of Rome gave no authority to do this. This was adopted on the morning of 30 June 1970, a few hours before the applications to join were officially received. This ensured that the regulations became part of the acquis communautaire before the new members joined, obliging them to accept the regulation. At first the UK refused to accept the rules but by the end of 1971 the UK gave way and signed the Accession Treaty on 22 January 1972, thereby handing over an estimated four fifths of all the fish off Western Europe. Norway decided not to join. Greenland left the EC in 1985, after having gained partial independence in 1979.

When the fisheries policy was originally set up the intention was to create a free trade area in fish and fish products with common rules. It was agreed that fishermen from any state should have access to all waters. An exception was made for the coastal strip, which was reserved for local fishermen who had traditionally fished those areas. A policy was created to assist modernisation of fishing vessels and on-shore installations.

·         Unlike the heavy subsidies and relative cost of the CAP, the CFP currently represents 0.75% of the EU budget. The fishing industry is a small component of EU GDP, contributing less than 1.0%.

·         Criticism of CFP by conservationists and those in the commercial fishing industry has been intense over the years, with blame for the decline in fishing stocks pointing in many directions.

·         Reforms and amendments to the CFP have occurred routinely over the years, but ultimately little satisfactory progress has been made, and many in Britain still cited the intrusion of CFP as another reason to leave the EU.

1972: The people of Norway vote in a referendum, rejecting membership in the EEC by a majority of 53.5%. This is partially due to Norway wanting to maintain control over its fishing grounds and fishing industry, which is the second largest contributor to GDP in Norway after oil. Norway remains in the EFTA.

1973: Denmark, Ireland and the UK complete negotiations, sign the accession treaties and join the EEC, leaving the EFTA.

1981: Greece joins the EEC.

1986: Spain and Portugal join the EEC.

1987: The ongoing enlargement of the EEC leads to a desire to further integrate the foreign policy and economies of the members. The Single European Act (SEA) was the first major revision of the Treaty of Rome. It was developed and signed in 1986, and came into force in 1987. The Act extended powers, made some reforms and set an objective for the European Community of establishing a single market by December 31, 1992. The import of the Act was to pave the road for the establishment of the European Union (EU).

·         A single market is an area where there are no restrictions to the free movement of goods, services, capital and people.

1988: Throughout the build-up of the EEC and eventually the EU, many members and nations expressed varying degrees of concern about the supranational nature of the European Community (EC) and the loss of sovereign powers – or delegation of sovereign authority – to the EC. In her famous Bruges speech in September 1988, then Prime Minister of Britain Margaret Thatcher, summed up the “eurosceptic” view:

“To try to suppress nationhood and concentrate power at the centre of a European conglomerate would be highly damaging (...) We certainly do not need new regulations which raise the cost of employment and make Europe's labour market less flexible and less competitive with overseas suppliers  (...) And certainly we in Britain would fight attempts to introduce collectivism and corporatism at the European level - although what people wish to do in their own countries is a matter for them".

-excerpted from The Single European Act and the road toward the Treaty of the European Union.

Editor’s note: Ok, here is where my already abysmal grasp of European politics and culture clashes fails completely. But an absurdly condensed timeline of events: ramifications from the cold war between the USSR and the US, civil protests and revolutions in eastern Europe against Communist rule, eventually led to the collapse of the Soviet Union and later re-unification of Germany from 1989-1992. This dramatically changed the perceived balance of power and economic landscape in Europe and globally. There is ongoing pressure from many countries to expand the EC, and resistance from some EC leaders and members to do so.

1992: The European Economic Area (EEA) is proposed in 1989 by then-EC president Jacques Delors, as an alternative to expanding the EEC. The EEA agreement is signed in 1992 by the then seven states of the EFTA and the then 12 member states of the EC, and becomes effective in 1994.

·         The EEA allows members of the EFTA access to the internal market within the EU.

·         EEA members are required to adopt most EU legislation concerning the single market, with notable exceptions for the laws governing agriculture and fisheries.

·         The EEA provides for the free movement of persons, goods, services and capital within the internal market of the EU.

1992: Switzerland rejects ratification of the EEA Agreement. Switzerland remains a member of the EFTA and over time negotiates a series of bilateral trade agreements with the EU.

Sidebar: There has been an enormous amount of ink, political speculation and media commentary devoted to Britain modeling either the “Norway model” or the “Swiss model” for its future relationship with the EU. Functionally the two options boil down to EFTA membership with the EEA agreement (Norway) or EFTA membership with bilateral trade agreements (Switzerland). We will delve into this in detail in a later post. Below are excerpts from a recent article  by Espen Eide, a former foreign minister of Norway and current resident of Switzerland (edited for brevity).

Could Britain mimic the ”Norway model” or the “Swiss model” when it exits the EU?

As an EEA member, Norway does not participate in decision-making in Brussels, but we loyally abide by Brussels’ decisions. We have incorporated approximately three-quarters of all EU legislative acts into Norwegian legislation – and counting. We have legally secured access to the single market, and we practise the free movement of people, goods, services and capital. Norway is more closely integrated into many aspects of the EU than even some of the EU’s members. Our subscription to freedom of movement and our membership of the Schengen area means that Norway has even higher per capita immigration than Britain.

Those campaigning for Britain to leave the EU and chose the Norwegian way can hence correctly claim that a country can retain access to the single market from outside the EU. What is normally not said, however, is that this also means retaining all the EU’s product standards, financial regulations, employment regulations, and substantial contributions to the EU budget. A Britain choosing this track would, in other words, keep paying, it would be “run by Brussels”, and it would remain committed to the four freedoms, including free movement.

British voters might also hear about the virtues of the “Swiss model”. It so happens that I currently live in Switzerland. My new alpine homeland is in most respects in a similar position to Norway, but instead of the EEA, it has chosen an array of bilateral agreements with the EU on most aspects of integration.

Compared to the EEA arrangement it can be seen as an even more cumbersome way of integrating into a EU-led market. Where the EEA is dynamic – which means it trails the developments of EU policy in all relevant areas – the Swiss arrangements are static. Crucially, too, they don’t cover services, which are so central to Britain’s economy.

To make the point louder: services = financial services. If Britain wants its banking and financial services industry to retain single market access to the EU, it will likely need to pursue EEA and EFTA membership (the “Norway model”). Unfortunately this would not allow Britain to regain control of its borders and immigration – which was a crucial motivation for many who voted to exit the EU.

1993: Passage of the SEA immediately led to drafting of the Maastricht Treaty (also known as the Treaty on European Union or TEU), whose goals were to strengthen supranational powers creating the European Union (EU), increase economic integration, establish some fiscal and monetary policy objectives and eventually lead to a monetary union (e.g. the introduction of the euro as a common currency). The Maastricht Treaty was drafted in 1991 and came into force in 1993. The EC was officially absorbed by the EU.

1994: Norway has a second referendum on EU membership, which is rejected by a 52.2% of voters. Norway remains in the EFTA.

Why did the majority of Norwegians not want Norway to become a member of the EU?

A recent response to this exact question, from the Minister Counsellor for Culture and Communication of at the Royal Norwegian Embassy in Paris, Rune Bjastad (edited for brevity):

“The arguments for saying ‘no’ were that membership was a threat to the sovereignty of Norway, the fishing industries and agriculture would suffer, that membership would result in increased centralisation, and there would be less favourable conditions for equality and the welfare state. Fishing is extremely important to the Norwegian economy, especially for coastal areas. It is the second largest industry in our country, after oil.

“But we must immediately say that economically, Norway is already part of the EU Internal Market. The question may be a bit misleading: in fact, we are strongly integrated in the European Union, even if we are not members.

“Economically, we are equal with other member states, through the Agreement on the European Economic Area, the so-called EEA. Since 1994, Norway has participated fully in the Internal Market.

“The Norwegian economy is strong, unemployment is low. Norwegians therefore see no economic argument in favour of EU membership.”

1994: The second stage of the Economic and Monetary Union of the EU is launched with the establishment of the European Monetary Institute. Austria, Sweden and Finland also join the EU.

Sidebar: The UK chose not to join the European Monetary Union (EMU). Its currency remains the pound sterling, which has taken a heck of a beating – hitting a 30+ year low against the US dollar – since the Brexit vote on June 23^rd.

1999: The euro becomes the official currency of the European Monetary Union (EMU), and the European Central Bank (ECB) begins operations.

2002: Euro notes and coins are put into circulation and the euro replaces old EMU member currencies entirely. There is heady talk that the euro could soon equal or supplant the dollar as the preeminent global reserve currency.

For the record, to date the euro has never even come close to matching the ubiquity, trading volume, perceived safety and global currency status of the US dollar. In our next post we will touch on this when we discuss the more recent developments in the EU.