How does Europe’s single market work?

Be it sluggish growth performance, high unemployment or an incomplete monetary union, completing the single market is often offered as a silver bullet to alleviate or solve most of the current problems of the EU. However, seldom is time taken to explain what the underlying mechanics of the single market are and how the latter is supposed to deliver all these positive effects for the EU.

In a recently published Working Paper, we have aimed to bridge this gap by offering a holistic reflection on the theoretical channels of single-market-induced growth and have verified their relevance, building on existing empirical literature.

Figure 1. The single market at work

Source: Bruegel

Figure 1 sketches some of the theoretical channels through which the four freedoms (labour, capital, goods, and services) are supposed to stimulate growth and employment. However, mostly due to data limitations, verifying and quantifying these channels at micro-level is all but methodologically trivial. Furthermore, aggregating the individual (micro-level) channels to estimate the overall (macro-level) impact of the single market on GDP requires extraordinarily audacious modelling assumptions. This has resulted in a wide variety of studies yielding sharply different results (see Table 1).

Table 1: Summary of studies and main macroeconomic effects of the single market

Source: Bruegel

All in all, however, even taking all this into account, it is safe to conclude that the impact of the single market has somewhat fallen short of initial expectations. Certainly the Single Market Programme has not succeeded in reversing the declining (though still positive) trend in EU productivity growth and its gap with the US. In our view, this is for three broad reasons:

1. Barriers remain prevalent under several headings. Although the exact degree of integration (or lack thereof) might be difficult to assess, it appears evident that the EU single market is far from complete. Along with the economic literature, we identify problems of a) poor quality of directives’ implementation, b) insufficient mutual recognition, c) a highly fragmented public procurement and d) services market, and finally e) significant barriers to the free movement of workers.

2. Key complementary policies to the abolition of barriers were not put in place. Albeit important, the prevailing barriers in the single market tell only part of the story. In several areas, even fully abolishing barriers does not translate into the automatic engendering of a common market. For example, the mere recognition of the right of establishment failed to spark significant integration of the banking sector at European level, which rather required the creation of a single supervisor and a common resolution mechanism (see Pisani-Ferry et al, 2012). Similarly for workers, the creation of a truly integrated European labour market might require not only better recognition of professional diplomas and pension portability, but rather wide-ranging coordination of welfare policies.

3. Some national policies were not supportive of the positive effects of the single market. National regulations protecting undue rents, rigid labour market rules, industrial policy supporting national champions, prevailing public monopolies, cumbersome procedures to set up new businesses, to mention just a few, are all policies that will hamper the crucial process of ‘creative destruction’ and attenuate the benefits of the single market, even in a situation in which all barriers are removed. At the same time, an effective national welfare system is fundamental to ensure that there is not just ‘destruction’ but rather ‘creative destruction’ and that, as unproductive firms shut down, capacities are not wasted but rather re-channelled to productive sectors and firms.

With this last point in mind, one can then interpret the single market as a catalyst, rather than a motor, of growth. Reforms of product and labour markets, together with policies increasing the effectiveness of welfare systems, while keeping public finances under control, will boost competitiveness and growth. A complete functioning single market will then amplify the positive effect of these reforms. However, if progress is not made under these headings, the single market cannot act as a substituting policy to bring Europe back to growth.

A key observation is that although the overwhelming prediction is for the single market to generate positive aggregate effects, specific categories might be negatively affected. A large part of the constituencies that currently show support for Eurosceptic parties are possibly to be ascribed to this category. If this were true, and given points 2 and especially 3 above, failures in national policies and welfare systems are to be partly blamed for the opposition that is currently being channelled against the EU and the single market.

Perhaps precisely because of the acknowledgment of the heterogeneous effects arising from further integration, and led by the desire to overcome distributional conflicts, the approach of the Commission in the past has been to adopt wide-ranging directives and regulations aimed at completing the single market across the board – the 1992 SMP being the most notable case. Recently however, we note a policy shift towards a more targeted approach.

The Juncker Commission has identified the main priorities for the single market as the establishment of a Capital Market Union, and the completion of the European energy and digital markets. This targeted approach might cater better to focusing on setting up the ‘complementary policies’ we have mentioned. But without comprehensive support from member states entailing not only devolution of powers but also appropriate national redistribution policies, those initiatives are likely to face increasing political resistance, significantly affecting the chances that the single market will deliver the benefits expected of it since its inception.

This article was originally published by Bruegel, the Brussels-based think tank. Read the article on their website here.

Publication does not imply endorsement of views by the World Economic Forum.

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Author: Alessio Terzi is an Affiliate Fellow at Bruegel. Mario Mariniello is a Research Fellow at Bruegel. André Sapir is a Senior Fellow at Bruegel.

Image: European Union flags fly outside the European Commission headquarters in Brussels. UNICS REUTERS/Thierry Roge