CHAPTER I.

SHORT HYSTORY OF THE EUROPEAN UNION The first concrete move for regional integration in Europe was made in 1947 with the establishment of Economic Commission for Europe (ECE). Also, in 1948 the Organization for European Economic Cooperation (OECC) was formed and was followed a year later by the Council of Europe. These marked the beginning of the splitting of Western Europe into two camps, with, on the one hand, the UK and some of the countries that later formed the European Free Trade Association (EFTA), and, on the other, Belgium, France, West Germany, Italy, Luxembourg and the Netherlands, usually referred to as the Original Six that subsequently established the European Economic Community (EEC). The next step in the economic and political unification of Western Europe was taken in 1951, when the European Coal and Steel Community was created by the Six and marked the parting of ways in post-war Western Europe. In June 1955, at Messina, Italy, at the meeting of the foreign ministers of the Six was considered the memorandum proposed by Belgium, Netherlands and Luxembourg regarding the establishment of a general common market and specific measures in the fields of energy and transport. The governments of the Six established that a general common market and an atomic energy pool should appear. In the end, after three years of negotiations, the Six agreed that the drafting of two treaties, one to create a general common market and another to establish an atomic energy community, should begin. Treaties were subsequently signed in Rome on 25 March 1957. The EEC and
1

Euratom came into being on 1 January 1958. Thus, in 1958 the Six belonged to three

separate entities: the ECSC 2 , EEC 3 and Euratom. Later became convenient to consider the three entities as branches of the same whole, with EEC becoming the dominant partner. The whole structure was named European Communities, or European Community (EC), whose main constitutional base was the Treaty of Rome, creating the EEC. The need of institutional strengthening of EC become more clear by introduction of summit meetings which try to bring national political leaders more closely into the EC affaires. In 1974 these were formalized under the name of European Council. The 1969-1972 periods can be described as one of great activity. In 1970 the Six reached a common position on the development of a Common Fisheries Policy (CFP). At a Paris summit in 1973 an agreement was reached on the

1 2

European Atomic Energy Commission European Coal and Steel Community 3 European Economic Community

development of new policies in relation to industry and science and research. The summit envisaged a more active role for the EC in the area of regional policy and decided that a European Regional Development Fund (ERDF) should be created to channel EC resources into the development of the backward EC regions. New members, like Greece (1981), Spain (1986) and Portugal (1986) entered the EC. On 1 July 1987 the Single European Act (SEA) became operative. The SEA contained policy development which was based upon the intention of creating a true single market by the end of 1992 with free movements of goods, services, capital and labour. Even more European countries applied between 1989-1992. Among them we can name Austria, Finland, Sweden and Switzerland and Norway shortly followed them. Cyprus and Malta applied in 1990. Formal negotiations were opened in 1998 with those states most likely to succeed: the Czech Republic, Estonia, Hungary, Poland and Slovenia. However the instability in Balkans and the war in Kosovo showed the need to hasten the process and, at 4 Helsinki, in December 1999, it was agreed to open accession talks with Bulgaria, Latvia, Lithuania, Malta, Romania and Slovakia. Certainly, an organization with such a large and varied membership would be very different from the original EEC of the Six. This is one reason why pursuing the questions of enlargement was made consequent upon the finalizing of the
5

Maastricht Treaty and

agreement upon new financial and budgetary arrangements for the existing member states. The enlargement facing the EU today poses a unique challenge, since it is without precedent in terms of scope and diversity: the number of candidates, the area (increase of 34%) and population (increase of 105 million), the wealth of different histories and cultures. A single set of trade rules, a single tariff, and a single set of administrative procedures will apply not only just across the existing Member States but across the Single Market of the enlarged Union. In order to assist the countries that have applied to become members of the European Union to carry out the reforms required for membership and to equip themselves to benefit from EU funds on accession, the Union provides financial assistance as part of its PreAccession Strategy. A new meeting of the European Council took place in December 1991, at Maastricht and produced a new blueprint for the future. It tried to integrate the EC further through setting out a time table for full economic and monetary unit (EMU), introducing institutional changes
4 5

Helsinki European Council; 10, 11 December 1999 Treaty on European Union, 7 February 1992

and developing political competences, the whole being brought together in the Treaty on European Union (Maastricht Treaty) of which the EC should form a part of a wider European Union. The Amsterdam 6 conference, which followed in 1997, updated aims and policies, tried to clarify the position regarding foreign and defense policies and justice and home affaires, and strengthened the social side. The treaty itself modified the existing treaties, notably those on the EEC and on the Union, which can be considered together with the acquis communitaire (legislation deriving from the treaties), as the constitution of the EU. The Amsterdam treaty gives EU a more coherent structure, a modern statement of its aims and policies, and brings some necessary improvements in the working of the institutions. The EU after the Amsterdam treaty has broad objectives but these naturally interfere with those in the Maastricht treaty. The classic aim is to develop an even closer union. It promotes economic and social progress, meaning the abolition of internal frontiers, better economic and social cohesion to assist the less-developed members to catch up with the EU average (creation of the Cohesion Fund in 1993) and an economic and monetary unit, complete with a single currency. It wants to create an international identity through a common security and defense policy. It has introduced a formal citizenship and has also taken steps to strengthen the commitment to democracy, to individual rights, to promote equality and to combat discrimination. The treaty has also established the EU, as an area of free movement, security and justice. Internally, the EU has general economic objectives relating to the single market, agriculture and transport, the aim of economic and social cohesion and a new emphasis on policy making in employment, social and environmental matters. Another important step in the EU development was the Nice Treaty7 , which took place on 11 December 2000. The treatys main concern was with EU enlargement, especially with the institutional changes that would be needed to accommodate 12- 15 new members.

6 7

The Amsterdam Treaty, 2 October 1997 The Nice Treaty, 26 February 2001

CHAPTER II. THE ECONOMICS OF EUROPEAN INTEGRATION

Fundamental Concepts

A. Purpose and progress of economic integration The expression 'economic integration' covers a variety of notions. It may refer to the absorption of a company in a larger concern. It may have a spatial aspect, for instance if it refers to the integration of regional economies in a national one. In case of EU, economic integration is always used with respect to international economic relations, to indicate the combination of the economies of several sovereign states in one entity. Economic integration is not an objective in itself, but serves higher objectives. The immediate, economic, objective is to raise the prosperity of all cooperating units. The fartherreaching objective is one of peace policy; namely, to lessen the chance of armed conflicts among partners. Polacheck (1980), using data for 30 countries in the 1958-1967 period, showed that doubling the trade between two countries leads to a 20 per cent decline in the frequency of hostilities. Used in a static sense, 'economic integration' represents a situation in which the national components of a larger economy are no longer separated by economic frontiers but function together as an entity. Used in a dynamic sense it indicates the gradual elimination of economic frontiers among member states (that is to say, the abolition of national discrimination), with the formerly separate national economic entities gradually merging into a larger whole. Of course, the static meaning of the expression will apply in full once the integration process has passed through its stages and reached its object.

Objects of integration Economic integration is basically the integration of markets. Economists make a distinction between markets of goods and services on the one hand, and markets of production factors (labour, capital, entrepreneurship) on the other. Free movement of goods and services is the basic principle of economic integration.

As is well known from classical international trade theory the free exchange of goods promises a positive effect on the prosperity of all concerned. It permits consumers to choose

the cheapest good, generally widens the choice, and creates the conditions for further gain through economies of scale, etc. The obvious welfare gains from the liberalisation of product markets are a good economic reason to start integration with that object. However, integration schemes tend to follow a political logic rather than an economic one. The political reasons to begin integration at the goods market are: - lasting coalition between sectors demanding protection and sectors and consumers demanding cheap imports is hard to accomplish; - substitute instruments (such as industrial policy, non- tariff barriers, and administrative procedures) can be used to intervene in the economic process; - vital political issues like growth policy and income redistribution are guaranteed to remain within national jurisdiction. Free movement of production factors can be seen as another basic element of

economic integration. One argument for it is that it permits optimum allocation of labour and capital. Sometimes, certain production factors are missing from the spot where otherwise production would be most economical. To overcome that problem, entrepreneurs are apt to shift their capital from places of low return to more promising places. The same is true of labour: employees will migrate to regions where their labour is more needed and therefore better rewarded. A second argument is that an enlarged market of production factors favours new production possibilities which in turn permit new, more modern or more efficient uses of production factors (new forms of credit, new occupations, etc.). The choice of production factors as the object of the second stage in the integration process is partly based on the economic advantages that spring from such integration. But here, too, we have to consider the political logic. The integration of labour markets seems to be the obvious choice in periods of a general shortage of labour A tangle of national regulations for wages, social security, etc. seems to leave politicians sufficient opportunities for practical intervention on the national level for them to accept general principles on the European level. With capital-market integration the issue of direct investments seems straightforward; many politicians may hope to attract new foreign investment in that way. For other capital movements the willingness to integrate is less obvious because integration would imply giving up the control of sensitive macroeconomic instruments.

Policy approximation is the next stage of economic integration. In an economy which leaves production and distribution entirely to the market, the elimination of obstacles to the movement of goods and production factors among countries would suffice to achieve full economic integration. Not so in modern economies, which are almost invariably of the mixed type, the government frequently intervening in the economy. In economies of the mixed type, integration cannot be achieved without harmonising the policies pursued by the governments of the individual states. Policy making is on the whole more difficult to integrate than markets for goods, services and production factors. Politicians are likely to be the more unwilling to give up their intervention power, the more such elements are involved as employment policy or budgetary policies (referring to expenditure on schools, subsidies, as well as revenues from taxes). Moreover, national civil servants tend to uphold their way of operating interventional schemes as the most efficient, and since their very existence depends on complicated sets of rules, they are hardly inclined, in general, to cooperate towards harmonised policy. Thus, the conditions for a common currency or monetary integration will not readily be met. That is one reason why currency integration is mostly introduced at a late stage of integration. Even later comes the integration of points that touch the very heart of a nation's sovereignty, in particular the acceptance of a common defence policy.

B. Positive and negative integration With respect to modern mixed economies, Tinbergen (1954) distinguished negative integration (that is, the elimination of obstacles), and positive integration (that is, the creation of equal conditions for the functioning of the integrated parts of the economy). The former's demand on policy will be relatively simple (deregulation, liberalisation), but the latter will always involve more complex forms of government policy (harmonisation, coordination). Let us look somewhat closer at the differences. Negative-integration measures are often of the simple 'Thou shalt not' type. They can be clearly defined, and once negotiated and laid down in treaties, they are henceforth binding on governments, companies and private persons. There is no need for permanent decisionmaking machinery. Whether these measures are respected is for the courts to check, to which individuals may appeal if infringements damage their interests. Positive integration is more involved. It often takes the form of vaguely defined obligations requiring public institutions to take action. Such obligations leave ample room for 8

interpretation as to scope and timing. They may, moreover, be reversed if the policy environment changes. As a consequence, they hold much uncertainty for private economic agents, who cannot derive any legal rights from them. Positive integration is the domain of politics and bureaucracy rather than law. No wonder then that positive integration does not present a built-in stimulus for progress. Because politicians are more likely to opt for positive rather than negative integration, progress is likely to be slower, the higher the stage of integration, that is the farther integration proceeds on the path towards a Full Economic Union.

C. Stages of economic integration As international trade and investment levels continue to rise, the level of economic integration between various groups of nations is also deepening. The most obvious example of this is the European Union, which has evolved from a collection of autarkical nations to become a fully integrated economic unit. Although it is rare that relationships between countries follow so precise a pattern, formal economic integration takes place in stages, beginning with the lowering and removal of barriers to trade and culminating in the creation of an economic union. These stages are summarized below. A. FREE TRADE AGREEMENTS The first level of formal economic integration is the establishment of free trade agreements (FTAs) or preferential trade agreements (PTAs). FTAs eliminate import tariffs as well as import quotas between signatory countries. These agreements can be limited to a few sectors or can encompass all aspects of international trade. FTAs can also include formal mechanisms to resolve trade disputes. The North American Free Trade Agreement (NAFTA) is an example of such an arrangement. Aside from a commitment to a reciprocal trade liberalization schedule, FTAs place few limitations on member states. Although FTAs may contain provisions in these areas if the signatory countries agree to do so, no further harmonization of regulations, standards or economic policies is required, nor is the free movement of capital and labour a necessary part of a free trade agreement. FTA signatory countries also retain independent trade policy with all countries outside the agreement.

However, in order for an FTA to function properly, member countries must establish rules of origin for all third-party goods entering the free trade area. Goods produced within the free trade area (and subject to the agreement) may cross borders tariff-free, but rules of origin requirements must be met to prove that the good was in fact produced in the exporting country. In the absence of rules of origin, third-party countries seeking trade access to the FTA area will choose the path of least resistance the country where they face the lowest opposing tariff in order to gain effective entry to the entire FTA region. B. CUSTOMS UNION A customs union (CU) builds on a free trade area by, in addition to removing internal barriers to trade, also requiring participating nations to harmonize their external trade policy. This includes establishing a common external tariff (CET) and import quotas on products entering the region from third-party countries, as well as possibly establishing common trade remedy policies such as anti-dumping and countervail measures. A customs union may also preclude the use of trade remedy mechanisms within the union. Members of a CU also typically negotiate any multilateral trade initiative (such as at the World Trade Organization) as a single bloc. Countries with an established customs union no longer require rules of origin, since any product entering the CU area would be subject to the same tariff rates and/or import quotas regardless of the point of entry. The elimination of the need for rules of origin is the chief benefit of a customs union over a free trade area. To maintain rules of origin requires extensive documentation by all FTA member countries as well as enforcement of those rules at borders within the free trade area. This is a costly process and can lead to disputes over interpretation of the rules as well as other delays. A CU would result in significant administrative cost savings and efficiency gains. In order to gain the benefits of a customs union, member countries would have to surrender some degree of policy freedom specifically the ability to set independent trade policy. By extension, because of the increased importance of trade and economic measures as foreign policy tools, customs unions place some limitations on independent foreign policy as well.

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C. COMMON MARKET A common market represents a major step towards significant economic integration. In addition to containing the provisions of a customs union, a common market (CM) removes all barriers to the mobility of people, capital and other resources within the area in question, as well as eliminating non-tariff barriers to trade, such as the regulatory treatment of product standards. Establishing a common market typically requires significant policy harmonization in a number of areas. Free movement of labour, for example, necessitates agreement on worker qualifications and certifications. A common market is also typically associated whether by design or consequence with a broad convergence of fiscal and monetary policies due to the increased economic interdependence within the region and the effect that one member countrys policies can have on other member countries. This necessarily places more severe limitations on member countries ability to pursue independent economic policies. The principal advantage of establishing a common market is the expected gains in economic efficiency. With unfettered mobility, labour and capital can more easily respond to economic signals within the common market, resulting in a more efficient allocation of resources. D. ECONOMIC UNION (AND MONETARY) The deepest form of economic integration, an economic union adds to a common market the need to harmonize a number of key policy areas. Most notably, economic unions require formally coordinated monetary and fiscal policies as well as labour market, regional development, transportation and industrial policies. Since all countries would essentially share the same economic space, it would be counter-productive to operate divergent policies in those areas. An economic union frequently includes the use of a common currency and a unified monetary policy. Eliminating exchange rate uncertainty improves the functioning of an economic union by allowing trade to follow economically efficient paths without being unduly affected by exchange rate considerations. The same is true of business location decisions.

11

Supranational institutions would be required to regulate commerce within the union to ensure uniform application of the rules. These laws would still be administered at the national level, but countries would abdicate individual control in this area. Basic Elements of the Stages of Economic Integration Free (FTA) Customs Union (CU) Common Market (CM) Trade Agreement Zero tariffs between member countries and reduced non-tariff barriers FTA + common external tariff CU + free movement of capital and labour, some policy harmonization Economic Union (EU) CM + common economic policies and institutions

Full economic union (FEU) implies the complete unification of the economies involved, and a common policy for many important matters. The situation is then virtually the same as that within one country. Given the many areas integrated, political integration (for example, in the form of a confederacy) is often implied. The transitions between the various stages of integration are fluent and cannot always be clearly defined. The first stages, FTA, CU and CM, seem to refer to market integration in a classical laissez-faire setting, the higher stages (EU, MU, FEU) to policy integration. In practice, however, the former three stages are unlikely to stabilise without some form of policy integration as well (for instance, safety regulations for a FTA, commercial policy for a CU, or social and monetary policies for a CM (Pelkmans, 1980). between a customs union and full integration, a variety of practical solutions for concrete integration problems are likely to occur. The stages of integration just sketched have two characteristics in common. They abolish discrimination among actors from partner economies (internal goal). They may thereby maintain or introduce some form of discrimination with respect to actors from economies of third countries (external goal).

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D. Degrees of policy integration Because countries are free to negotiate economic integration agreements as they see fit, in practice, formal agreements rarely fall neatly into one of the four stages discussed above. This can lead to some confusion of terminology and also confusion as to the state of economic integration in some parts of the world. In the case of Canada, for example, the country is part of a free trade area with the United States and Mexico. However, the North American Free Trade Agreement also includes provisions that partially liberate the flow of labour and capital in the region an element of a common market. In addition, Canada has in the past pushed to curtail the use of trade remedy measures within North America. While this represents a desire to advance one aspect of North American integration, the next formal step a customs union does not appear to be a policy priority at this time. All forms of integration described above require permanent agreements among participating states with respect to procedures to arrive at resolutions and to the implementation of rules. In other words, they call for partners to agree on the rules of the game. For an efficient policy integration, common institutions (international organisations) are created. However, for the higher forms of integration, such as a common market, the mere creation of an institution is not sufficient: they require transfer of power from national to union institutions. All forms of integration diminish the freedom of action of the member states' policy-makers. The higher the form of integration, the greater the restrictions and loss of national competences. The following hierarchy of policy cooperation is usually adopted: - Information: partners agree to inform one another about the aims and instruments of the policies they (intend to) pursue. This in-formation may be used by partners to change their policy to achieve a more coherent set of policies., However, partners reserve full freedom to act as they think fit, and the national competence is virtually unaltered. - Consultation: partners agree that they are obliged not only to inform but also to seek the opinion and advice of others about the policies they intend to execute. In mutual analysis and discussion of proposals the coherence is actively promoted. Although formally the sovereignty of national governments remains in-tact, in practice their competences are affected. - Co-ordination goes beyond this, because it commits partners to agreement on the (sets of) actions needed to accomplish a coherent policy for the group. If common goals are fixed some

13

authors prefer the term cooperation. Coordination often means the adaptation of regulation to make sure that they are consistent internationally (for example, the social security rights of migrant labour). It may involve the harmonisation (that is, the limitation of the diversity) of national laws and administrative rules. It may lead to convergence of the target variables of policy (for example, the reduction of the differences of national inflation rates). Although agreements reached by coordination may not always be enforceable (no sanctions), they nevertheless limit the scope and type of policy actions nations may undertake, and hence imply limitation of national competences. - Unification: either the abolition of national instruments (and their replacement with union instruments for the whole area) or the adoption of identical instruments for all partners. Here the national competence to choose instruments is abolished.

E. Goods markets Advantages Fully integrated goods markets imply a situation of free trade among member states. People aim for free trade because they expect economic advantages from it, namely: - more production and more prosperity through better allocation of production factors, each country specialising in the products for which they have a comparative advantage; - more efficient production thanks to scale economies and keener competition; - improved 'terms of trade' (price level of imported goods with respect to exported goods) for the whole group in respect of the rest of the world. Integration of goods markets implies first of all the removal of (all) impediments to free internal goods trade. In modern mixed economies such negative integration is not sufficient, however. For the market to function adequately there must be common rules for competition on the internal market and for trade with third countries.

Obstacles to free trade The free-trade area has been defined before as a situation where there are neither customs duties or levies with similar effect, nor quantitative restrictions or indeed any factor impeding the free internal movement of goods (the latter are often taken together under the heading of non-tariff barriers, or NTB). They can be described as follows:

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- Customs duties or import duties are sums levied on imports of goods, making the goods more expensive on the internal market. Such levies may be based on value or quantity. They may be indicated in percentages or vary according to the price level aspired to domestically; - Levies of similar effect are import levies disguised as administrative costs, storage costs or test costs imposed by the customs; - Quantitative restrictions (QR) are ceilings put on the volume of imports of a certain good allowed into a country in a certain period (quota), sometimes expressed in money values. A special type is the so-called "tariff quota', which is the maximum quantity which may be imported at a certain tariff, all quantities beyond that coming under a higher tariff; - Currency restrictions mean that no foreign currency is made available to enable importers to pay for goods bought abroad; - Other non-tariff impediments are all those measures or situations (such as fiscal treatment, legal regulations, safety norms, state monopolies, public tenders, etc.) which ensure a country's own products' preferential treatment over foreign products on the domestic market.

Motives for obstacles Obstacles to free trade are mostly meant to protect a country's own trade and industry against competition from abroad, and therefore come under the heading of protection. Protection can be combined with free trade. A customs union, for instance, prevents free trade with outside countries by a common external tariff and/or other protectionist measures, while leaving internal trade free. Like individual countries, a customs union may-hope to benefit from protection against third countries, that is, from import restrictions. From the extensive literature we have distilled the following arguments in favour of such measures: - Independence from other countries as far as strategic goods are concerned, a point much stressed in the past and especially in times of war; - The possibility of nurturing so-called "infant industries'. The idea is that young companies and sectors which are not yet competitive should be sheltered in infancy in order to develop into adult companies holding their own in international competition; - Defence against dumping. The healthy industrial structure of an economy may be spoiled when foreign goods are dumped on the market at prices below the cost in the country of origin. Even if the action is temporary, the economy may be weakened beyond resilience;

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- Defence against social dumping. If wages in the exporting country remain below productivity, the labour factor is said to be exploited; importation from such a country is held by some to uphold such practices and is therefore not permissible; - Employment boosting. If the production factors in the union are not fully occupied, protection can turn the demand towards domestic goods, so that more labour is put to work and social costs are avoided; - Diversification of the economic structure. Countries specialised in one or a few products tend to be very vulnerable; marketing problems of such products lead to instant loss of virtually all income from abroad. That argument applies to small developing countries rather than to large industrialised states; - Shouldering-off balance-of-payment problems. Import restrictions reduce the amount to be paid abroad, which helps to avoid adjustments of the industrial structure and accompanying social costs and societal friction (caused by wage reduction and a restrictive policy, etc.). Pleas for export restriction have also been heard. The underlying ideas vary considerably. The arguments most frequently heard are the following: - Some goods are strategically important and must not fall into the hands of other nations; that is true not only of military goods (weapons) but also of incorporated knowledge (computers) or systems; - Exportation of raw materials means the consolidation of a colonial situation; a levy on exports will hopefully increase people's inclination to process the materials themselves. If not, then at any rate the revenues can be used to start other productions; - If too much of a product is exported, the importing country may be induced to take protective measures against a series of other products; rather than that, a nation may accept a 'voluntary' restriction of the exports of that one product.

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CHAPTER III. DECISION-MAKING IN THE EUROPEAN UNION AFTER AMSTERDAM

1 THE DIFFERENT KINDS OF EUROPEAN UNION LAW There are three different kinds of law in the European Union (EU): i. Primary legislation, i.e. the Treaties (see Annex 1) and other agreements possessing similar status; ii. Secondary legislation, i.e. the regulations, directives, decisions, recommendations and opinions based upon the Treaties (see below); iii. Case law, i.e. judgements of the European Court of Justice and of the Court of First Instance. Collectively they are known as the Acquis communautaire . Primary legislation is agreed on the basis of direct negotiations between Member States' governments. Such agreements are drawn up in the form of treaties which are subject to ratification in national parliaments (but not by the European Parliament!). The same is true of any subsequent amendments to them. In some Member States, recourse may be had to a referendum. THE TREATIES The European Union is based upon and governed in accordance with a number of Treaties between the Member States. These Treaties are the most fundamental part of the acquis communautaire and in every case have been the subject of (sometimes prolonged) negotiations leading to unanimous agreement amongst governments and ratification by national parliaments and, in some cases, by referendum too. The Treaties not only serve as the Unions constitution but are also prescriptive in that several of them set objectives for the future, usually accompanied by a deadline and sometimes by a precise timetable. Most of the 17

Treaties contain provision for their own amendment and, with one exception, were concluded for an unlimited period. In common with the rest of the acquis communautaire, the Treaties must be accepted in their entirety by states wishing to join the Union. The table below lists the main Treaties and Acts in chronological order, together with the date of entry into force and a brief summary, where relevant, of how each relates to the others. The first three Treaties, establishing three legally distinct Communities are sometimes referred to as the founding Treaties.

Treaty European Coal and Steel

In force 1952

Summary Concluded for 50 years amongst the Six on the basis of the Schuman Plan

Community(ECSC) Treaty (Treaty of Paris, 1951) European 1957) Economic Community 1958

Concluded on the model of the ECSC Treaty but with a much broader range of objectives; the most important of the Treaties

(EEC) Treaty (Treaty of Rome,

European

Atomic

Energy

1958

A sector-specific Treaty of limited application

Community (EAEC or Euratom) Treaty (also signed in Rome, 1957) Treaty establishing a Single Council and a Single Commission of the European Communities (Merger Treaty, 1965) Treaty amending certain Budgetary Provision of the Treaties establishing the European Communities (and of the Merger Treaty) (Treaty of Luxembourg, 1970) 1971 July 1967

Amended

the

ECSC,

EEC

and

Euratom Treaties to create a Council and a Commission serving all three Communities Laid down a new procedure for settling the Budget and introduced the system of own resources

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Treaty amending certain Financial Provisions establishing Treaty) (1975) Act concerning the election of the representatives Parliament by of the European universal direct of the the Treaties European

1978

Refined the budgetary procedure to give the European Parliament more power and set up the Court of Auditors

Communities (and of the Merger

1978

The basis for the first (1979) and subsequent European elections

suffrage (European Elections Act, 1976)elections Single European Act (1986) July 1987 Amended and expanded the EEC Treaty (most importantly by extending the scope of qualified majority voting) and laid down new procedures for foreign policy co-operation Treaty on European Union November 1993 Established Treaty; the European the coUnion; decision of

(Maastricht Treaty, 1992)

amended and expanded the EEC created procedure; created pillars

Common Foreign and Security Policy (CFSP) and Co-operation in the Fields of Justice and Home Affairs (JHA) Treaty of Amsterdam (1997) 1999 Amended the Maastricht Treaty and the EEC Treaty; extended co-decision; added new provisions on social policy; incorporated the Schengen acquis into EEC Treaty; created constructive abstention; strengthened transparency Treaty of Nice (2001) 2003 Istitutional structure changes

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Acquis communautaire: a phrase used to cover all legislation in force including the Treaties in their entirety, all Directives, Regulations, Decisions, Trade and Association Agreements as well as the case law of the European Court of Justice and of the Court of First Instance. Secondary legislation is drawn up using a variety of different procedures, depending upon the Treaty article chosen by the Commission as the legal base for the proposal in question. Case law results from judgements of the European Court of Justice and of the Court of First Instance meeting Luxembourg, normally in response to referrals from national courts or as a result of actions brought by the Commission in its capacity as the guardian of the Treaties. The different types of secondary legislation are: i. Regulations: binding and directly applicable in all Member States without any implementing national legislation. Management of the day to day aspects of the Common Agricultural Policy, for example, is by means of regulations. ii. Directives: binding on the Member States with respect to the result to be achieved and with respect to the deadline, but with the choice of method left to the Member States. Directives have to be implemented in national legislation in accordance with each Member State's own procedures. There can be a substantial delay between the approval of a directive in the Council of Ministers and its implementation in the national law of the Member States. Enforcement - by no means even - is normally the responsibility of the national authorities. iii. Decisions: may be issued either by the Council or by the Commission and are binding upon those to whom they are addressed, normally a Member State or a commercial enterprise. No national implementing legislation is required. iv. Recommendations and Opinions: have no binding effect, and may be issued either by the Council or by the Commission.

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2 THE INSTITUTIONS 2.1 The European Council At least twice a year, the Heads of State or Government meet as the European Council to provide the Union with overall direction and to reach decisions on the key issues. European Council meetings (sometimes known as Summits) are also attended by Member States' Foreign Ministers and by the President of the Commission and the President of the European Parliament. European Council agreements have no legislative force, but must first be turned into legislation on the basis of a proposal from the Commission in the normal way. The European Council is an institution that stands over the three pillars of the EU, that links them together and that takes on a central leadership role. If the Council of Ministers has always been embodied in the European Treaty, the same does not apply for the European Council. The European Council was established as a result of the summit meetings involving Heads of State and Governments which have been taking place since 1969. These meetings used to take place at irregular intervals; a resolution passed at the Paris Summit Conference in 1974 made them a permanent fixture in the shape of the European Council, yet they were not embodied in the Treaty establishing the European Community. The European Council deals with the central issues effecting the EU, in particular those connected with European Political Cooperation (EPC) which is an institution founded in 1970 at intergovernmental level in an attempt to coordinate foreign policy. Because of its composition, the European Council developed into the highest decision-making authority - although this was not intended by the treaties. Its role was made more explicit with the Single European Act (SEA) in 1986/87. The Treaty of Maastricht on European Union followed on from this, confirming the Council's function of driving forward European union as a whole and locking together the different policy areas. Article D of the Treaty establishing the European Union states: "The European Council shall provide the Union with the necessary impetus for its development and shall define the general political guidelines thereof". This applies in particular for the guidelines concerning Common Foreign and Security Policy, with the Treaty of Amsterdam, which came into force on the 1st of May 1999, even providing for policy-making power over the Western European Union.

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The European Council is also regularly engaged when the ministers of departments in the Council of Ministers are unable to reach agreement and package deals which stretch across policy areas become necessary. There is no doubt that the European Council as the European Union's dedicated body for reflecting the intergovernmental components of the Union has gained a great deal of influence over the past few decades. Indeed, following the introduction of the new constitution, which, since the "No" votes from the referendums in France and the Netherlands, has failed for the time being, would have increased even more. Having said this, however, it would be wrong to conclude that there was a general trend in the EU towards more intergovernmentalism.

2.2 The Council of Ministers The Council is composed of the Ministerial representatives of the Member States. Ministers of Agriculture attend Council meetings when agriculture is being discussed, Ministers of Transport when transport matters are on the agenda, and so on. The Council, which has its own secretariat of EU civil servants, is the supreme legislative authority in the Union, although in an increasing number of areas its power is exercised jointly with the European Parliament. The Council takes decisions: by unanimity, by simple majority, by qualified majority, each Member State's vote being "weighted" in accordance with its population. Member States take turns to hold the Presidency of the Council for a period of six months. Council meetings are prepared by a Committee of Member States' Permanent Representatives (i.e. Ambassadors) known as COREPER. Formally known as the Council of Ministers, the Council of the European Union is the central decision-making authority in the EC. The Council is responsible for passing laws proposed by the Commission and with the involvement of the European Parliament. This has been the Community's fundamental decision-making procedure from the very beginning. The relative weight of the three institutions involved, however, has changed. The capacity in which members attend Council meetings changes according to the policy area being discussed for

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example the European Community of Agricultural Ministers or Environmental Ministers might meet. Moreover, the respective member of the Commission is also present. Work in the Council would take up a large proportion of the time available to ministers from member states. Given that they can only spend short periods in Brussels, they need support. The Committee of Permanent Representatives of the EC (COREPER) in Brussels plays and important role here. It is made up of the permanent representatives from the member states in Brussels and their deputies and meets up on a weekly basis. This Committee is responsible for monitoring and coordinating the work of around 250 committees and working groups, which are staffed by civil servants from the member states. These, in turn, are responsible for preparing the dossiers for COREPER and the Council at a technical level. COREPER deals with most of the decision-making preparations as far as content is concerned. The Council's Secretariat encompasses a staff of around 2,500 working in six departments. Its duties are primarily of an administrative nature, meaning that it is responsible for things such as preparing the agenda for work to done, drawing up reports, translation services, looking into legal questions etc. The illustration below offers an insight into the structure of the Council. All decisions were initially taken using a system of unanimous voting because of the Luxemburg Compromise. Since the mid 1980s, however, and especially since the Treaty of Maastricht and the Treaty of Amsterdam there has been an increasing move towards qualified majority voting as the basis for decision making. This development has continued following the Treaty of Nice. That being said, however, the expansion of qualified majority voting goes hand-in-hand with a major obstacle to the ability to apply this procedure brought about by the triple majority rule (a qualified majority of weighted votes, a majority of states and a qualified majority of populations (62%), which was also set down in the Treaty of Nice. In addition to this, the European Parliament's powers of co-decision have been consistently expanded.

2.3 The European Commission It is currently composed of 25 members (November 2005), who are proposed by the governments of the member states and appointed for a five-year term; it is now also subject to a vote of appointment by the European Parliament before it can be sworn in. The

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commissioners are not appointed as negotiators for their respective states, but are supposed to act completely independently in the best interests of the Community. They are supported by a staff of around 20,000 officials - less than some large cities! which is split up into 24 socalled directorates general (such as transport, agriculture, external relations, regional policy etc.) and nine services, which, in turn, are also split up into directorates and departments. The Commission's main tasks can be summarized under four headings. Right of initiative: Every decision taken by Council has to be based on a proposal from the Commission. The Commission's task is to act as an engine of integration drawing up proposals for the development of Community policy. This right and authority to determine the EU's agenda, to submit proposals at a particular juncture and to link differing initiatives together gives the Commission considerable influence in the legislative procedure. Guardian of treaties: The Commission is responsible for monitoring the application of treaty provisions and decisions made by other EC institutions and can appeal to the European Court of Justice when violations are identified. Executive authority for the implementation of Community policy: This includes the administration of finances as well as the implementation of EC policies. Of course, this does not mean that the Commission is responsible for making sure that the countless number of decrees and guidelines are implemented in individual member states. Bearing in mind the size of the Commission's staff, this would be an impossible task. No, this is carried out by the administrations in the member states or their regional sections. The main task of the Commission, then, is to monitor and supervise the actions being taken by the member states. External representation: The Commission represents the EU at the GATT negotiations and international organisations; this sometimes takes place together with the member states and/or the respective presidents. The most important characteristics of the Commission are: Its distinct differentiation at a functional level and the fact that it represents a multi-national bureaucracy using an extensive system of committees (commitology) within which very close cooperation takes place both with the administrations of member states and with national and European associations

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Under the Maastricht Treaty, the Commission's term of office was extended to five years to coincide with the European Parliament's term. The appointment of the President and other members of the Commission is subject to the approval of the Parliament. 2.4 The European Parliament The European Parliament (EP) is our first institution at a supranational level that carries a name familiar to us from national political systems. While the EP might sound familiar, it is quite different from national parliaments. If the role played by and the powers available to the EP in the Community have changed constantly ever since the foundation of the ECSC, these changes have also steadily increased its influence within the EU. Important milestones in this regard have been the extension of its budget powers in (1975), the introduction of the first direct elections (1979), the introduction of the cooperation procedure (1986) and the introduction of the codecision procedure (1992), as well as considerable expansion of this codecision procedure into other areas of application since the Treaty of Amsterdam. Other changes have also been introduced with the Treaty of Nice. The role of the EP as a co-legislator together with the Council of Ministers were further expanded and strengthened. EP is composed of cross-national parties, such as the European People's Party and European Democrats (EPP-ED), which with 279 MPs currently represents the most powerful grouping in the Parliament, and the Party of European Socialists (SPE/E) with 199 MPs. This illustration also shows you the number of MPs sent by each of the member states. The Parliament's 20 standing committees are incredibly important for the work of the EP and its influence During their 5 years in office, those members of the European Parliament who are active in the committees are able to acquire a great deal of specialist knowledge. This specialist knowledge not only enables them to follow the work being carried out by the Directorates General, the Commission and the Council of Ministers, it also enables them to bring more influence to bear than the official description of their responsibilities would suggest. Another important aspect in this respect is their close cooperation with the respective Commission departments and with transnational and national associations.

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The main characteristics of the EP can be summarized thus: The European Parliament is a multi-national chamber undergoing constant change; it features ideological - differing political groupings from across the member states - and national differences - nationality of the MPs from the individual member states. As with the other institutions addressed so far, the European Parliament also demonstrates significant functional differentiation. And, finally, the incredibly close links and intensive cooperation with the Commission, often against the Commission, should also be emphasized. Making an assessment based on a comparison with national parliaments depends on how one looks at it. From a statistical point of view taken today, it can be said that the importance of the EP still lags behind that of national parliaments, but goes much further than anything found in parliamentary chambers or committees in international organisations. View the development of the European Parliament during the last two decades, however, and it is strikingly clear that its importance compared to the other institutions has grown enormously: Another important indication of the "supranationalization" of the EC. The Parliament and the Council constitute the Union's joint budgetary authority. The Parliament has to give its assent to any trade, co-operation, association or membership agreement concluded between the Union and a non-member country. Under the Maastricht Treaty, the Parliament was given the right to set up committees of enquiry and to appoint an Ombudsman to investigate allegations of maladministration by the institutions of the Union. 2.5 The European Court of Justice The European Court of Justice (ECJ), just like the European Parliament, sounds familiar to systems existing in national states. Indeed, its power of jurisdiction also corresponds to that often found in national democratic political systems. The ECJ is responsible for making sure Community law is upheld. It is responsible for ruling on legal disputes between member states, on disputes between the EU and member states, on disputes between EU institutions and authorities as well as on disputes between individual citizens and the Union. In addition to this, judges in member states can turn to the Court of Justice to rule on pending cases involving the interpretation of Community law.

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There is also a Court of First Instance that exists alongside the Court of Justice. The Court of First Instance was established in 1989 to ease the Court of Justice's workload. Its jurisdiction includes direct actions from citizens and companies against the actions or failure of EU bodies to act, as well as action for damages against the EU. Employment conflicts between the EU and its employees have been handled by the Civil Service Tribunal since the autumn of 2005. There are two ways of calling in the ECJ. The first is over the preliminary rulings procedure, which permits national courts to apply for an interpretation of certain aspects of Community law to help these national courts to reach a decision on a current case. The second way is over direct petitions. But its actual influence only really becomes clear after taking a look at its work in individual areas. The European Court of Justice has been a major influencing factor in making the constitution of the EU more supranational by laying down rules such as the principle of direct effect - which means for every citizen without having to call in national states first - of EU law and the primacy of Community law over national law.

Moreover, the European Court of Justice has also had a large bearing on other areas of EU policy. For example, in a revolutionary ruling it established the principle of mutual recognition of standards in other member states, which put an end to the extremely slow and time-consuming process of harmonising standards and, in turn, went a long way to making the internal market project possible. One of the main reasons for the ECJ's influence came as a result of a clever, targeted and successful strategy to incorporate the national courts into the administration of EU justice.

Looking at this, it might be easy to get the impression that these landmark decisions were made in the past and that they can no longer be taken to reflect the influence of the ECJ today. A more recent judgement (November 2005), however, demonstrates that it would be quite wrong to get this impression. This judgement might lead to the Commission gaining influence in the area of criminal law and has led to heated discussions.

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The European Court of Justice, consisting of 25 judges and 8 Advocates-General, is based in Luxembourg. So, it is responsible for arbitrating in disputes relating to the interpretation and application of the Treaties and of legislation based upon them. Its judgements are binding upon those to whom they are addressed and it has the power to levy fines on firms found to be in breach of Union law. Under the Maastricht Treaty, the Court also has the power to impose fines on Member States which fail to carry out their Treaty obligations. 2.6 The Court of First Instance This Court was established by Article 11 of the 1987 Single European Act and first became operational in 1989. It consists of 25 judges, one from each Member State. There are no Advocates-General. It has jurisdiction over a number of fields but of particular importance to business are its powers in competition and intellectual property law and over the Commissions anti-dumping procedures. 2.7 The Court of Auditors The Court of Auditors, composed of one Member from each Member State, is also based in Luxembourg. It is responsible for overseeing all expenditure from the Budget of the Union. Its findings are contained in an annual report submitted to the Council and the European Parliament. The Court, which has no power of sanction, may also undertake special investigations into particular sectors of the Budget. 2.8 The Economic and Social Committee (ECOSOC) Set up in 1957 by the Treaty of Rome, members of ECOSOC appointed by the Council on the recommendation of Member States' governments and have a four-year term of office. ECOSOC consists of representatives of employers (Group 1), workers (Group 2) and various interest groups (Group 3). It covers areas such as agriculture and fisheries, industry and commerce, financial and monetary questions, social and cultural affairs, transport and communications, trade and development policy, nuclear questions and research, regional development, environment and consumer affairs. On its own initiative it can offer opinions on other subjects covered by the Treaties. The Treaty of Amsterdam allows the European Parliament to consult ECOSOC.

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2.9 The Committee of the Regions The Maastricht Treaty established a new European Union body, the Committee of the Regions, which is based in Brussels. Composed of representatives of regional and local bodies and appointed by the Council for a four-year term on a proposal from the Members States, the Committee has advisory status along the same lines and across broadly the same range of issues as the Economic and Social Committee. Its nationality composition is identical with that of the Economic and Social Committee 3 THE LEGISLATIVE PROCESS Legislation may be adopted under the Consultation Procedure, the Co-operation Procedure or the Co-Decision Procedure. The choice of procedure depends upon the Treaty article which the Commission has chosen as the legal base for its proposal. Until the entry into force of the Single European Act in July 1987, all legislation was adopted under the simplest of these procedures, known as the Consultation Procedure. This procedure requires the Council to obtain the opinion of the European Parliament (and sometimes also the opinions of ECOSOC and the Committee of the Regions) before adopting legislation. However, neither the Council nor the Commission is obliged to accept the amendments contained in the Parliaments opinions and it is only by refusing to give an opinion that the Parliament can exert pressure. Once the Parliament has given its opinion, the Council can adopt the proposal unamended, adopt it in an amended form, or be unable to agree. In the last case the proposal remains "on the table". The Co-operation Procedure, introduced in 1987, allows the Parliament two opportunities to scrutinise and possibly amend the Commissions proposal. At the first stage, the Parliament, ECOSOC and the Committee of the Regions give their opinions in the same way as under the Consultation Procedure. Only the Parliament can propose amendments. The Commission indicates which amendments it accepts before the proposal is forwarded to the Council, which then draws up its "common position". Studies have shown that about 40 per cent of the Parliaments amendments are accepted at this stage. The Councils common position is sent back to the Parliament which may within three months approve it, reject it, or adopt

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amendments to it. The Council may then adopt the proposal in question, although it can do so only by unanimous agreement : i. when it wishes to amend a proposal on its own initiative; ii. when it decides to take up amendments which have been proposed by the Parliament but rejected by the Commission; iii. when it decides to adopt a common position which the Parliament has rejected; iv. when it wishes to override amendments which the Parliament has adopted by an absolute majority (314 votes) at second reading and which are supported by the Commission. The Maastricht Treaty (effective from November 1993) introduced the Co-Decision Procedure in order to strengthen the Parliaments influence over legislation. Once the Treaty of Amsterdam comes into effect, the Co-Decision Procedure will replace the Co-operation Procedure in all but a very few areas and become the normal mode of Council-Parliament involvement in legislation. The essential difference between the two procedures is that the Co-Decision Procedure : allows for the convening of a Conciliation Committee in which at the final stage differences between the Council and the Parliament may be resolved; allows the Parliament, as a last resort, the right to reject the proposal outright by an absolute majority. Under the Co-Decision Procedure, the Council and the Parliament are jointly responsible for the final adoption of legislation. It has been estimated that some 60 per cent of the Parliaments amendments are incorporated into the legislation.

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5 THE INTER-GOVERNMENTAL PILLARS The Maastricht Treaty created a European Union which rests upon three "pillars". The central pillar is the European Community (EC) itself and the decision-making procedures described here are those which apply to action within the EC pillar, normally known as the "first pillar". The procedures in the other two pillars (the Common Foreign and Security Policy and Cooperation in the fields of Justice and Home Affairs) are different, for although the Council of Ministers plays much the same role, the legislative instruments are not the same. The Commission is less influential and recourse cannot be had to the Court of Justice. Action in these fields is essentially intergovernmental in character. Under both pillars, provision exists for the European Parliament to be kept informed and consulted. Members of the European Parliament are also entitled in the normal way to put questions to the Council of Ministers. In so far as action is taken under either heading which involves a charge to the Budget of the Union, the Parliament's powers with respect to the Budget (see above) may be brought into play.

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CHAPTER IV. THE BUDGET OF EU I. The expenses made from the budget

Actions and projects funded by the EU budget reflect the priorities set by the EU countries at a given time. These are grouped under broad spending categories (known as headings) and thirty-one different policy areas.

The EU budget finances actions and projects in policy domains where all EU countries have agreed to act at Union level. Such decisions are taken for very practical reasons. Joining forces in these areas can yield greater results and costs less. There are other policies, however, where the EU countries decided not to act at Union level. For example, national social security, pension, health or education systems are all paid for by national, regional or local governments. The 'subsidiarity principle' ensures that activities best managed at national, regional or local level are funded at the most appropriate level and that the Union does not intervene. a. For growth and jobs For the next seven years, the EU countries have decided to dedicate a considerable part of their joint efforts and of the EU budget to creating more economic growth and jobs. Sustainable growth has become one of the main priorities of the Union. The EU economy needs to be more competitive and less prosperous regions need to catch up with the others.

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Over the period 200713, out of every euro spent from the EUs annual budget, eight cents will go to make the EU more competitive. Achieving long-term growth also depends on tapping and increasing the EUs growth potential. This priority, known as 'Cohesion', calls for helping especially less advantaged regions transform their economy to face global competition. Innovation and the knowledge economy provide an unprecedented window of opportunity to trigger growth in these regions. Out of every euro spent, 36 cents will go to such cohesion activities.

b. Natural resources Thanks to their geographic and climatic diversity, the EU countries produce a large variety of agricultural products, which European consumers can buy at reasonable prices. The EU efforts in this field have two main goals. First, what is produced must correspond to what consumers want, including high safety and quality for agricultural products. Second, on the production side, the farming community should be able to plan and adapt production to consumers demand while respecting the environment. In addition, a successful management and protection of our natural resources must also include direct measures to protect the environment, restructure and diversify the rural economy and promote sustainable fishing. After all, animal infections, oil spills and air pollution do not stop at national borders. Such threats require extensive action on many fronts and in several countries. Over the period 200713, 43 cents out of every euro will be spent from the EU budget each year in favour of our natural resources. c. Fundamental freedoms, security and justice Similarly, the fight against terrorism, organised crime and illegal immigration is much more effective when EU countries share information and act together. The EU strives for a better management of migration flows into the Union and extensive cooperation in criminal and judicial matters as well as secure societies based on the rule of law. About one cent in every euro from the EU budget will be spent to this end.

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d. Being European: Debate, dialogue and culture More than 495 million of people live in the EU. They speak many different languages and have different cultural backgrounds. Together they form the invaluable wealth of the European Union: cultural diversity built on common values. The EU budget promotes and protects this cultural heritage and richness, while encouraging active participation in social debates around us. It also aims to protect public health and consumer interests. About one cent in every euro will go to such activities under this heading known as Citizenship. e. Global player The impact of EU funds does not stop at our external borders. For many, the EU budget delivers the most needed emergency aid in the aftermath of a natural disaster. For others, it is a long-term assistance for prosperity, stability and security. About six cents in every euro go to cooperation with countries about to join the Union, other neighbouring countries, and indeed to poorer regions and countries around the world. f. Administrative costs Around six cents in every euro are spent on running the European Union. This covers the staff and building costs of all EU institutions, including the European Parliament, Council of Ministers, European Commission, European Court of Justice and European Court of Auditors.

II. The sources of money The European Union has its 'own resources' to finance its expenditure. Legally, these resources belong to the Union. Member States collect them on behalf of the EU and transfer them to the EU budget. Own resources are of three kinds (the figures below refer to the forecasts for 2007).

Traditional own resources (TOR) these mainly consist of duties that are charged on imports of products coming from a non-EU state. They bring in approximately EUR 3 billion or 15 % of the total revenue. 34

The resource based on value added tax (VAT) is a uniform percentage rate that is applied to each Member States harmonised VAT revenue. The VAT-based resource accounts for 15 % of total revenue, or some EUR 17.8 billion.

The resource based on gross national income (GNI) is a uniform percentage rate (0.73 %) applied to the GNI of each Member State. Although it is a balancing item, it has become the largest source of revenue and today accounts for 69 % of total revenue or EUR 80 billion.

The budget also receives other revenue, such as taxes paid by EU staff on their salaries, contributions from non-EU countries to certain EU programmes and fines on companies that breach competition or other laws. These miscellaneous resources add up to around EUR 1.3 billion, i.e. about 1 % of the budget. The total EU revenue for 2007 amounts to some EUR 116.4 billion, while the total of the funds committed under different policies is slightly higher. The difference mainly results from the budgetary practice of the EU, where the European Commission commits, i.e. blocks, the total amount required for a multi-annual project in the first year of the project. The actual payments, however, are made in several instalments during the project period.

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Revenue flows into the budget in a way which is roughly proportionate to the wealth of the Member States. The UK, the Netherlands, Germany, Austria and Sweden, however, benefit from some adjustments when calculating their contributions. On the other hand, EU funds flow out to the Member States in accordance with the priorities that the Union has identified. Less prosperous Member States receive proportionately more than the richer ones and most countries receive more than they pay in to the budget. III. The decision procedure of the budget The Commission, Parliament and Council of Ministers have different roles and powers in deciding the budget. As a first step, these three institutions conclude a binding agreement to ensure budgetary discipline, long-term planning and to enhance cooperation in connection with annual budgets. This interinstitutional agreement includes the multi-annual financial framework, which establishes annual upper limits (known as ceilings) per heading. Annual budgets must respect these ceilings. The most recent financial frameworks cover the seven-year periods from 2000 to 2006 and 2007 to 2013. The budgetary procedure as established in the EU treaties lasts from 1 September to 31 December. In practice, it begins much earlier. For example, preparations for the 2007 budget started before the end of 2005. There are two types of budget expenditure: compulsory and non-compulsory expenditure. Compulsory expenditure covers all expenditure resulting from international agreements and the EU treaties. All other expenditure is classified as non-compulsory. The Council of Ministers has the final word on compulsory expenditure and the European Parliament on non-compulsory expenditure. The importance of this distinction has declined with successive interinstitutional agreements as they collaborate closely at all stages. Commissions preliminary draft budget All EU institutions and bodies draw up their estimates for the preliminary draft budget according to their internal procedures.

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The Commission consolidates these estimates and establishes the 'preliminary draft budget', which takes into account the guidelines or priorities for the coming budget year. The Commission submits the preliminary draft budget to the Council of the Union in April or early May before the budget Council meets in July. The Council of Ministers and the Parliament must work on the basis of this proposal from the Commission. Council's first reading of the budget After a conciliation meeting with the Parliament, the Council of Ministers adopts the draft budget with amendments, if any, which is forwarded to the Parliament in September. Parliaments first reading At its first reading in October, the Parliament may decide to amend the Council's draft. It will discuss controversial matters in 'trialogue' meetings with the Council Presidency and the Commission beforehand. Parliament's first reading, along with its suggestions, is then referred back to the Council. Councils second reading Before its second reading in November, the Council has a further conciliation meeting with the Parliament and tries to reach an agreement on the whole of the budget. It then adopts its second reading. Parliament adopts or rejects the budget (second reading) The Parliament may modify the Councils latest text before it votes on the final budget in December. If approved, the President of the Parliament signs the budget into law. The Parliament may also reject the budget. Similar procedures apply to the adoption of letters of amendment to the preliminary draft budget (presented when new information comes to light before the adoption of the budget) and of amending budgets (in the case of inevitable, exceptional or unforeseen circumstances occurring after the budget has been adopted).

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IV. The structural funds The Structural Funds are the primary source of European Union funding, with the exception of support for agriculture. Some 90% of the European Union finance available for projects goes to the Structural Funds. Through the Structural Funds, the European Union aims to support those regions which are less developed or in industrial decline, and to support training schemes for those seeking reentry into employment. The present rules for Structural Funds apply from 2000 to the end of 2006. There are currently four main Structural Funds. These are: 1. European Regional Development Fund (ERDF): ERDF concentrates on lessfavoured regions. The main focus is on productive investment, infrastructure and SME development. There are also considerable funds available to support infrastructure development in SIP areas and community based regeneration. 2. European Social Fund (ESF): ESF supports human resource development measures (training and skills development). The main aim is to promote a high level of employment and social protection, equality between men and women, sustainable development, and economic and social cohesion. 3. European Agricultural Guidance and Guarantee Fund (EAGGF): The EAGGF finances the Common Agricultural Policy and rural development. 4. Fisheries Instrument for Fisheries Guidance (FIFG): FIFG supports projects related to fisheries restructuring and marketing. Objective Programmes The four Structural Funds combine to fund Objective Programmes. There are currently three Objectives through which funding is allocated. The Objectives are: Objective1 The Objective 1 Programme provides support for regions in Europe where development is lagging behind.

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Objective2 The Objective 2 Programme provides support for areas undergoing economic and social conversion Objective3 The Objective 3 Programme provides support to tackle long-term unemployment and social exclusion.

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CHAPTER V. MONETARY POLICY IN THE EU

1. Role and provisions of the European Monetary System The European Monetary System is being considered as a first attempt at Economic and Monetary Union, but it is really more like a mechanism devised for creating a zone of monetary stability. The idea was floated by German Chancellor, Helmut Schmidt and French President, Valery Giscard dEstating. The Council had adopted the idea, in the form of a resolution on the establishment of the European Monetary System (EMS) and related matters. The objectives were of stabilizing exchange rates, reducing inflation, and preparing for monetary integration. The provisions of the EMS were the following: 1. In terms of exchange rate management, the EMS will be at least as strict as the snake. 8 In the initial stages of its operation and for a limited period of time, member countries currently not participating in the snake may opt for somewhat wider margins around central rates. In principle, intervention will be in the currencies of participating countries. Changes in central rates will be subject to mutual consent. Non-member countries with particularly strong economic and financial ties with the Community may become associate members of the system. The European Currency Unit 9 (ECU) will be at the centre of the system; it will be used as a means of settlement between European Economic Communities monetary authorities. 2. An initial supply of ECUs (for use among Community central banks) will be created against deposits of US dollars and gold on the one hand, and member currencies on the other hand. The use of ECUs created against Member States currencies will be subject to conditions varying with the amount and the maturity. 3. Participating countries will coordinate their exchange rates policies vis--vis third countries. Ways to coordinate dollar interventions should be sought of, avoiding simultaneous
8

In 1972, the six Member States-Belgium , France, West Germany, Italy, Luxembourg and Netherlands- set up a snake in the tunnel mechanism to narrow the fluctuation margins between the Community currencies (the snake), in relation to fluctuations against the US dollar (the tunnel). 9 An abstract currency, a standard legal tender used to calculate the budgetary contributions of each Member State; it represented a basket of currencies adjusted periodically, to reflect the relative economic power of each Member State.

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reserve interventions. Central banks buying dollars will deposit a fraction and receive ECUs in return; likewise, central banks selling dollars will receive a fraction against ECUs. 4. No later than 2 years after the start of the scheme, the existing arrangements and instructions will be consolidated in a European Monetary Fund. 5. A system of closer monetary cooperation will only be successful if participating countries pursue policies conductive to greater stability at home and abroad; this applies to deficit and surplus countries alike. In essence, the EMS is concerned with the creation of an EC currency zone within which there is discipline in managing exchange rates. The discipline is known as the exchange rate mechanism (ERM), which asks a member nation to intervene to reverse a trend when 75% of the allowed exchange rate variation of 2.25% is reached. The EMS asks neither for permanently and irrevocably fixed exchange rates between the member nations nor for complete capital convertibility. Moreover, it does not mention the creation of a common central bank to be put in charge of the member nations foreign exchange reserves and to be vested with the appropriate powers. Hence, the EMS was not EMU, although it could be seen as paving the way for one.

2. The Delors Report By 1987 the EMS and the ERM within it appeared to have achieved considerable success in stabilizing exchange rates. This coincided with the legislative progress towards EMU and other fronts. The EC summit held in Hanover on 27 and 28 June 1988 decided that, in adopting the Single Act, the EC Member States had confirmed the objective of progressive realization of economic and monetary union. A committee composed of the central banks governors and two other experts, chaired by Jaques Delors, was given the task of studying and proposing concrete stages leading towards this union. The committee reported just before the Madrid summit, the following year, and its report is referred to as the Delors Report on EMU. The committee was of the opinion that the creation of the EMU must be seen as a single process, but in stages, progressively leading to the ultimate goal. Thus the decision to enter upon the first stage should commit a Member State to the entire process. Emphasizing that the creation of the EMU would necessitate a common monetary policy and require a high degree of compatibility of economic policies and consistency in a number of other policy areas, particularly in the fiscal field, the Report pointed out that the realization of the EMU 41

would require new arrangements which could be established only on the basis of a change in the Treaty of Rome and consequent changes in national legislations. According to the Report, the first stage should be concerned with the initiation of the process of creating the EMU. During this stage there would be a greater convergence of economic performance through the strengthening of economic and monetary policy consideration within the existing institutional framework. In the monetary field the emphasis would be on the removal of all obstacles to financial integration and of the intensification of cooperation and coordination of monetary policies. Realignment of exchange rates was seen to be possible, but effort would be made by every Member State to make the functioning of other adjustment mechanisms more effective. The committee was of the opinion that it would be important to include all EC currencies in the exchange rate mechanism of the EMS during this stage. The 1974 Council decision defining the mandate of central bank governors would be replaced by a new decision indicating that the committee itself should formulate opinions on the overall orientation of monetary and exchange rate policy. In the second stage, which would commence only when the Treaty has been amended, the basic organs and structure of the EMU would be set up. This stage should be seen as a transition period leading to the final stage; it should constitute a training process leading to collective decision-making, but the ultimate responsibility for policy decisions would remain with national authorities during this stage. The procedure established during the first stage would be further strengthened and extended on the basis of the amended Treaty, and policy guidelines would be adopted on a majority basis. In the monetary field, the most significant feature of this stage would be the establishment of the European System of Central Banks (ESCB) to absorb the previous institutional monetary arrangements. The ESCB would start the transition with a first stage in which the coordination of independent monetary policies would be carried out by the Committee of Central Bank Governors. It was envisaged that the formulation and implementation of a common monetary policy would take place in the final stage; during this stage exchange rates realignments would not be allowed barring exceptional circumstances. The final stage would begin with the irrevocable fixing of Member States exchange rates and the attribution to the EC institutions of the full monetary and economic consequences. It is envisaged that during this stage the national currencies would eventually be replaced by a single EC currency. In the economic field, the transition to this stage is seen to be marked by three developments: EC structural and regional policies may have to be further strengthened ; EC macroeconomic and budgetary rules and procedures would have to 42

become binding; and the EC role in the process of international policy cooperation would have to become fuller and more positive. In the monetary field, the irrevocable fixing of exchange rates would come into effect and the transition to a single monetary policy and a single currency would be made. The ESCB would assume full responsibility, especially in four specific areas: 1. The formulation and implementation of monetary policy. 2. Exchange-market intervention in third currencies. 3. The pooling and management of all foreign exchange reserves. 4. Technical and regulatory preparations necessary for the transition to a single EC currency. The Report was the main item for discussion in the EC summit in Madrid on 24 June 1989. In that meeting, member nations agreed to call a conference which would decide the route to be taken to EMU. Instead of insisting that the United Kingdom would join the exchange rate mechanism of the EC when the time is ripe, a surprisingly conciliatory Margaret Thatcher, the British Prime Minster, set out five conditions for joining: a lower inflation rate in the UK, and in the EC as a whole, abolition of all exchange controls (at the time and for two year after, Italy , France and Spain had them), progress towards the single EC market, liberalization of financial reserves and agreement on competition policy. All member nations endorsed the Report and agreed on 1 July 1990 as the deadline for the commencement of the first stage.

3. The Maastricht Treaty The three stage timetable for EMU did start on 1 July 1990 with the launching of the first phase of intensified economic cooperation during which all Member States were to submit their currencies to the EMS exchange rate mechanism. The second stage is clarified in the Maastricht Treaty. It was to start in 1994. During this stage the EU was to create the European Monetary Institute (EMI) to prepare the way for a European Central Bank (ECB) which would start operating on 1 January 1997. Although this was upset by the 1992 turmoil in the EMS, the compromised reached in Edinburgh summit in December 1992 did not water down the Treaty too much. Be that as it may, the Treaty allowed Denmark and the United Kingdom to opt out of the final stage when the EU currency rates would be permanently and irrevocably fixed in a single currency floated.

43

However, in a separate protocol, all the 12 EC nations declared that the drive to a single currency in the 1990s was irreversible. A single currency, to be managed by an independent ECB, was to be introduced as early as 1997, if seven of the then 12 nations passed the strict economic criteria required for its successful operation, and in 1999 at the very latest. These conditions are as follows: 1. Price stability. Membership required a price performance that is sustainable and an average rate of inflation, observed over a period of one year before the examination, that does not exceed by more than 1.5 percentage points that of, at most, the three best performing EC member countries. Inflation shall be measured by means of the consumer price index on a comparable basis, taking into account differences in national definitions. 2. Interest rates. Membership required that: observed over a period of one year before the examination, a Member State has had an average nominal long-term interest rate that does not exceed by more than 2% that of, at most, the three best performing Member States in terms of price stability. Interest rates shall be measured on the basis of long-term government bonds or comparable securities, taking into account differences in national definitions. 3. Budget deficits. Membership required that a member country has achieved a government budgetary position without a deficit that is excessive 10 . However, what is to be considered excessive is determined in Article 104c(6) which simply states that the Council shall decide after an overall assessment whether an excessive deficit exists. The Protocol sets the criterion for an excessive deficit as being 3% of GDP. However, there are provisions if either the ratio has declined substantially and continuously and reached a level that comes closer to the reference value; orthe excess over the reference value is only exceptional and temporary and the ratio remained close to the reference value. 4. Public debt. The ratio of government debt should not exceed 60% of GDP. But again there is an important provision unless the ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace. Whether such an excessive deficit exists is open to interpretation and is decided by the Council under qualified majority. In helping the Council decide, the Commission is to look at the medium term and quite explicitly can have the opinion that there is an excessive deficit if there is risk, notwithstanding the fulfilment of the requirements under the criteria. 5. Currency stability. Membership required that a member country has respected the normal fluctuation margin provided for by the exchange-rate mechanism of the EMS without

10

Article 109i

44

severe tensions for at least two years before the examination. In particular, [it] shall not have devalued its currencys bilateral central rate against any other Member States currency on its own initiative for the same period. The important requirements for a stable system are that no member should be able to run their economy in a way that increases the costs for the others. Provided that the minimum standard set is high enough, then the euro area as a whole will get the finest credit ratings/lowest interest costs. The timing of these convergence tests has been crucial. If they had occurred in 1992, only France and Luxembourg would have scored full marks, meaning five points. The others would have scored as follows: Denmark and the United Kingdom 4 points each; Belgium, Germany and Ireland 3 points each; the Netherlands 2 points; Italy and Spain 1 point each; Greece and Portugal zero points each. Hence, the EMU could not have been introduced. The position at the end of 1996 was even worse, since only Luxembourg qualified. Hence the third stage of EMU began in 1997. Then, only one country was deemed not to qualify: Greece. And even Greece was able to qualify at the first subsequent reassessment in 2000. The data on which the decision on 2 May 1998 was based was deemed, in the opinion of the EU Commission, to indicate that 11 nations had passed the test. Of the remaining four, three (Denmark, the U K and Sweden) had already decided not to join in the first wave, and Greece was not in the running. The Commissions interpretation of the Member States performance was clearly flexible. The following table shows the performances of each of the 15 Member States at that time, regarding the convergence criteria:

45

Table 1.1: EU Member States performance to the convergence criteria. Long Inflation Government budgetary position Exchang e rates term intere st rates
d

HICP a

Existen ce of an excessi ve deficit b

Deficit (%of GDP) c

Debt ( per cent of GDP )

ERM participa tion

Januar y 1998

1997

1997

Change from previous year

March 1998

Janu ary 1998

1997 2.7 e 1.1 1.4 1.9 1.3 1.2 1.4 5..2 1.2 1.8 1.4 1.8 Yes g * Yes * No No Yes * Yes * Yes No Yes * No No

199 6

199 5 7.8 f

Reference value Austria Belgium Denmark Finland France Germany Greece Ireland Italy Luxembou rg Netherlan

3 2.5 2.1 -0.7 0.9 3.0 2.7 4.0 -0.9 2.7 -1.7 1.4

60 66.1 122.2 65.1 55.8 58.0 61.3 108.7 66.3 121.6 6.7 72.1 -3.4 -4.7 -5.5 -1.8 2.4 0.8 -2.9 -6.4 -2.4 0.1 -5.0 0.3 3.8 Yes Yes Yes Yes** Yes Yes Yes h Yes Yes j Yes Yes

5.6 5.7 6.2 5.9 5.5 5.6 9.8 i 6.2 6.7 5.6 5.5

-4.3 -2.2 -2.7 -4.9 -0.4 -1.5 2.9 2.4 1.5 4.2 7.8 0.7

-9.6 -6.8 -0.2 -0.7 0.7 -1.9 0.2 1.2

46

ds Portugal Spain Sweden UK EU(15) 1.8 1.8 1.9 1.8 1.6 Yes * Yes * Yes * Yes * 2.5 2.6 0.8 1.9 2.4 62.0 68.0 76.6 53.4 72.1 -3.0 -1.3 -0.1 -1.3 -0.9 -0.9 4.6 0.8 2.0 2.1 2.9 3.5 3.0 Yes Yes No No 6.2 6.3 6.5 7.0 6.1

-0.9 -1.4

Source: Eijffinger& de Haan (2000) Fourteen Member States had government deficits of 3% on GDP or less in 1997; Belgium, Denmark, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, Finland, Sweden and the United Kingdom. Member States had achieved significant reduction in the level of government borrowing, in particular in 1997. This remarkable outcome was the result of national governments determined efforts to tackle excessive deficits combined with the effects of lower interest rates and stronger growth in the European economy. The Commissions report critically examined one-off measures which have contributed to some Member States 1997 figures. The report concluded that the major part of the deficit reductions were structural. In 1997 government debt was below the Treaty reference value of 60% of GDP in four Member States- Luxembourg, France, Finland, and the United Kingdom. According to the Treaty, countries may exceed this value as long as the debt ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace. This was deemed to be the case in almost all Member States with debt ratios above 60% in 1997. Only Germany, where the ratio was just above 60% of GDP and the exceptional costs of unification continued to bear heavily, was there a small rise in 1997. All countries above 60% ratio were expected to see reductions in their debt levels. The Commission concluded that the conditions were in place for the continuation of a sustained decline in debt ratio in future years.

4. Main elements orf Economic and Monetary Union Economic and Monetary Union has four broad ingredients: the euro and the single European monetary policy; the coordination of European macroeconomic policies through the Stability and Growth Pact (SGP); the Broad Economic Policy Guidelines (BEPG) and

47

related processes; the completion of the internal market; and the operation of the structural funds and other cohesion measures. Although the euro did not come into existence until 1 January 1999 and then only in financial markets, most of the characteristics of Stage 3 of EMU were operating once the European Central Bank (ECB) opened in June 1998. The ECB in the form of the European Monetary Institute (EMI) had been preparing for that day since 1994 with all of the EU national central banks (NCBs). The form of the coming single monetary policy was known already by 1998, both in framework and instruments. The generalized framework was incorporated in the Amsterdam Treaty.

The European Central Bank The European Central Bank was established in June 1998,is located in Frannkurt and is given total independence to carry out its mandate. The ECB and the 12 central banks of the euro adopting nations are known as the Eurosystem, which distinguishes them form the European System of Central Banks (ESCB) since the latter includes the central banks of all the 25 EU nations. The ECBs primary task is to ensure price stability in the euro area; price stability has been defined to be an annual increase in the consumer price index of less than 2%. To achieve this, a so-called two-pillar strategy is followed: i) setting a target for the growth of money supply, defined in the broadest sense; ii) assessing future price trends and risks to price stability by examining trends in wages, exchange rates, long-term interest rates. It is also responsible for collecting all necessary statistical information, from both the national authorities and economic agents, and for following developments in the banking and financial sectors and promoting the exchange of information between the ESCB and banking authorities. The ECB defines and implements monetary policy of the euro area; holds and manages the foreign exchange reserves of the euro area and conducts foreign exchange operations; issues euro notes and coins; and promotes the smooth operation of the payment systems. The head of the ECB is its Executive Board, which is responsible for the daily running of the bank, implementation of its monetary policy and transmitting the necessary instructions to the national central bank. It comprises the President, Vice-President and four other members, all six being appointed on the agreement of the nations in the euro area. All 48

six hold non-renewable eight-years terms. They are appointed by common accord of the governments of the member states at the level of the Heads of State or Government, on a recommendation from the EU Council, after it has consulted the European Parliament and the Governing Council of the ECB. The main responsibilities of the Executive Board are: i) prepare Governing Council meetings; ii) implement monetary policy for the euro area in accordance with the guidelines specified and decisions taken by the Governing Council. It gives the necessary instructions to the euro area NCBs; iii) manage the day to day business of the ECB; iv) exercise certain powers delegated to it by the Governing Council. The top decision making body of the ECB is the Governing Council, which comprises the six members of the executive board and the 12 governors of the euro area central banks. The president of the ECB acts as its chairperson. Its main responsibilities are: i) adopt the guidelines and take decisions to ensure the performance of the tasks entrusted to the Eurosystem; ii) formulate the monetary policy in the Euro area, including, as appropriate, decisions related to immediate monetary objectives, key interest rates and the supply of reserves in the Eurosystem; iii) establish the necessary guidelines for their implementation. The Governing Council meets twice a month at the Eurotower in Frankfurt am Main, Germany. At its first meeting each month, the Governing Council assesses monetary and economic developments and takes its monthly monetary policy decisions. At its second meeting, the council discusses mainly issues related to other tasks and responsibilities of the ECB and the Eurosystem. The minutes of the meetings are not published, but the monetary policy decision is announced at a press conference held shortly after the first meeting each month. The President, assisted by the Vice-President, chairs the press conference. There is also the General Council, consisting of the President and Vice-President of the ECB as well as the governors of the national central banks of all EU nations- 29 members 11 .It carries out the tasks taken over from the European Monetary Institute which the ECB is required to perform in Stage Three of Economic and Monetary Union (EMU) on account of the fact that not all EU Member States have adopted the euro yet. The General Council also contributes to: i) the ECBs advisory functions; ii) collection of statistical information; 49

iii) preparation of the ECB's annual reports; iv) establishment of the necessary rules for standardising the accounting and reporting of operations undertaken by the national central banks; v) taking of measures relating to the establishment of the key for the ECB's capital subscription other than those already laid down in the Treaty; vi) laying-down of the conditions of employment of the members of staff of the ECB; vii) the necessary preparations for irrevocably fixing the exchange rates of the currencies of the Member States with a derogation against the euro. In accordance with the Statute, the General Council will be dissolved once all EU Member States have introduced the single currency. The ECBs capital amounts to EUR 5.5 billion. The NCBs are the sole subscribers and holders of the capital of the ECB. The subscription of the capital is based on the basis of the EU Member States respective shares in the GDP and population of the Community. The fully paid-up subscriptions of euro area national central banks (NCBs) to the capital of the ECB amount to a total of 3.9bn euro. The EU non-euro area NCBs are required to contribute to the operational costs incurred by the ECB in relation to their participation in the European System of Central Banks by paying up a minimal percentage of their subscribed capital. From May 2004 these contributions represent 7% of their subscribed capital, amounting to a total of EUR 111,050,987.95 . The euro area and the NCBs pay up their respective subscriptions to the ECB capital in full. The NCBs of the non-participating countries pay up 5% of their respective subscriptions to the ECBs capital, as contribution to the operational costs of the ECB. In addition, the NCBs of the Member States participating in the euro area provide the ECB with foreign reserve assets of up to an amount equivalent to around EUR 40 billion. The contributions of each NCB are fixed in proportion to their share in the ECBs subscribed capital, while in return each NCB is credited by the ECB with a claim in euro equivalent to its contribution. The non-euro area NCBs are not entitled to receive any share of the distributable profits of the ECB, nor are they liable to fund any losses of the ECB. It should be stressed that the Eurosystem is independent. When performing Eurosystem-related tasks, neither the ECB, nor any member of their decision making bodies may seek to take instructions from any external body. The Community institutions and bodies and the governments of the Member States may not seek to influence the members of the decision-making bodies of the ECB or of the NCBs in the performance of their tasks. Both the

50

Eurosystem and the ESCB are not legal persons. According to the international public law, ECB is the core of the complex structure of the Eurosystem. The pursuit of monetary policy by the Eurosystem runs into a number of difficulties. In the Governing Council of the ECB, the Executive Board (6 persons) is a minority compared to the now 12 governors of the national central banks. The present ECB design could induce the Council to yield too much to the national interests of the governors. It will probably take quite a while before it is possible to shift to a majority of Council members appointed explicitly for the system as a whole. The problem is that, over the next 10-15 years, the imbalance can only grow worse, once candidate countries and perhaps todays outs join the euro. There is also a fundamental problem in the Eurosystem of one size fits all and there has been a debate on the technical virtues of inflation-targeting versus monetary targeting.

5. The Eurosystem The institutional system behind the single monetary policy is quite complex, because it has to deal with the fact that some EU members are not participants in Stage 3 of EMU (yet). The Treaty sets up the European System of Central Banks (ESCB), the ECB and the participating NCBs form the Eurosystem, which is what is running the monetary side of the euro area. The term Eurosystem has only been coined by its members, in order to make the set up clearer. The Eurosystem is relatively decentralized. It operates through a network of committees, where each national central bank and the ECB have a member. The ECB normally provides the chairman and the secretariat. The Governing Council takes the decisions but the Executive Board coordinates the work of the committees and prepares the agenda for the Governing Council. The Eurosystem also has a Monetary Policy Committee, but unlike the UK and many other central banks round the world, this is not the decision making body on monetary policy. It organizes and discusses the main evidence and discussion papers to be put before the Governing Council on monetary matters. The Eurosystem bank has a high degree of independence from political influence in exercising its responsibility. Not only is the taking or seeking of such advice explicitly prohibited, but the Governing Council members are protected in a number of ways in order to shield them from interest group pressures:

51

-They have long terms of office, eight years in the case of the Executive Board (and not renewable), so that they are less likely to have any regard for their prospects for their next possible job while setting the monetary policy; -The proceedings are secret, so the people cannot find out how they voted. Each member is supposed to act purely in a personal capacity and solely with the aims of price stability at the euro area level in mind, and without regard to national interests. No system can ensure this, but a well-designed one increases the chance of this happening substantially. More importantly, it can reduce any belief that the members will act with national or other interest in mind. -The Eurosystem is explicitly prohibiting from monetizing government deficits. The point of trying to achieve this independence is simply credibility- try to maximize the belief that the Eurosystem will actually do just what it has been asked to- namely maintaining price stability. This credibility comes from other sources than independence. The structure of the Governing Council is strongly reminiscent of that of the Bundesbank. The Bundesbank was highly successful in maintaining low inflation. By having a similar structure (probably assisted by the Frankfurt location, just a few kilometers down the road), the Eruosystem can hope to borrow much of the Bundesbanks credibility. The Eurosystem has a simple single objective of price stability. But for monetary policy to be credible, it is necessary that the objective should be clear enough for people to act on and that the central banks behaviour should be both observable and understandable. Here the ECB had to define the objective, since the Amsterdam Treatys concept of price stability is far too vague to be workable. They opted for inflation over the medium term of less than 2%. The inflation they were talking about, was defined as that in the Harmonized Index of Consumer Prices. After a swift clarification that this meant zero inflation was the lower bound, the specification was widely criticized for being too inexact. Not only is the length of the medium term not spelt out, but it is not clear how much and for how long prices can deviate from the target. Nor is there indication of how fast inflation should be brought back to the target after a shock hits. This means that a wide range of policy settings would be consistent with such a generalized target. Policy is thus not very predictable something the Governing Council has sought to offset by trying to give clear signals about interest rate changes. The inevitably diffused structure of decision making with 18 independent decision makers means that the

52

Eurosystem cannot offer a single and closely argued explanation of how it regards the working of the economy. Thus far, policy has been fairly successful, but since mid-2000, inflation has been stubbornly above 2%. Although it has been possible to blame the rapid rise in oil prices and some other shocks, the deviation is getting to the stage where it could have an effect on expectations. Until now, price inflation expectations have remained a little below 2%.

6. The Stability and Growth Pact and Excessive Deficit Procedure To support the likely success of the Euro in case of the fiscal criteria, the Stability Pact was agreed at the Dublin Council of December 1996 and confirmed in Amsterdam in June 1997 as follows: The reference value of a 3% deficit would constitute an absolute ceiling, except if the country concerned experiences a fall in GDP of over 2%. If a country is found (during the semi-annual evaluation performed by the Commission) to have a deficit in excess of 3% of GDP, it would have to make a noninterest-bearing deposit equivalent to 0.2% of GDP plus 0.1% for each point of the excess deficit. The variable part applies only for deficits up to 6% of GDP; the total is thus capped at 0.5% of GDP. The deposit will be returned as soon as the deficit goes below 3%; if the excess deficit persists for over two years, the deposit becomes a fine. This pact should help to prevent from substantial excessive deficits in a single country of the EMU and it is also supported by the second principle of the ECB, the political independence. The latter is seen as a necessary condition to ensure that printing money will not finance the budget deficits. The Stability Pact should help to keep fiscal discipline in the countries of the EMU in order to fulfill the target of the narrow fiscal convergence criteria every year. From time to time, the SGP has come under pressure, the greatest pressure not surprisingly coming in 2002 and 2003 when EU economy was not performing well. France, Germany and Portugal all triggered the first steps in EDP. However, while the second two countries have shown some embarrassment and regret, France refused to alter its stance on the grounds that it was not actually exceeding the 3% deficit, its debt ratio would remain inside 60%, and the results would be good for growth and the achievement of the longer term objectives of the EU. While breaches of the target ratios are unfortunate, the SGP is actually 53

strengthened when the penalty system is seen to come into operation and have an effect. Refusal to follow the requirement of the Pact, even while inside the limits, weakens the credibility of the system. It is clear that for Germany and France, the euro area has reached the point for the first time, where appropriate monetary policy for those countries on their own differs from that for the area as a whole. It is thus an unusual experience for what thought itself the core of the system to have to adjust to match the needs of the whole. Various proposals have been put forward for reforming the SGP and indeed the Commission has itself advanced proposals. EU finance ministers reached a hard won deal on reforms to the Stability and Growth Pact at an extraordinary meeting in advance of the EU summit of heads of state and government on 22 and 23 March 2005. In essence, big countries such as France and Germany have won concessions making the pact more flexible in various parts, adding up to a considerable relaxation of the rules. In return, countries like Austria and Netherlands have won references to enhanced surveillance, peer support and peer pressure. The two thresholds- 60% for debt and 3% for deficit remain unchanged. However, the following has changed: Trigger for an excessive deficit procedure: No excessive deficit procedure will be launched against a member state experiencing negative growth or a prolonged period of low growth. Previously, the exception was for countries in a recession defined as 2% negative growth, something which has been virtually unheard of among EU members. Relevant factors letting a country off an EDP: Member states recording a temporary deficit or one close to the 3% reference value will be able to refer to a series of relevant factors to avoid an EDP. Factors will include potential growth, the economic cycle, structural reforms, policies supporting R&D plus medium-term budgetary efforts. Rather than referring to an exhaustive list of relevant factors as had been mooted at one stage, the deal sets out chapter headings. These will take the form of general principles whose application will be thrashed out between member states and EU institutions. Leeway will be given where countries spend on efforts to "foster international solidarity and to achieving European policy goals, notably the reunification of Europe if it has a detrimental effect on the growth and fiscal burden of a member state". The first part of this phrase will go some way to pleasing France, which wanted public money to development and some military expenditure. Germany will also be pleased as it wanted special treatment for what it regards as its high contribution to the EU budget and will no doubt try to justify this as part of efforts "to achieve European policy goals". Germany also

54

appears to have got its way as regards the last part of the above text in that it is expected to cite the cost of German reunification. The Council and Commission have recognized the importance of pension reforms in an ageing society by agreeing to give "due consideration" to the implementation of these reforms in their budgetary assessments relating to the excessive deficit procedure. They note that carrying out such reforms leads to a short-term worsening of public deficits but a longterm improvement in the sustainability (public debt) of public finances. Extension of deadlines in connection with excessive deficit procedures: Countries will have two years (previously one) to correct an excessive deficit. This may be extended in cases of "unexpected and adverse economic events with major unfavorable budgetary effects occurring during the procedure". To benefit from these, countries must show proof that they have adopted the correction measures that were recommended to them. Member states have committed to using unexpected fiscal receipts during periods of strong growth to reduce their deficits and debt. Country-specific medium-term objectives: Medium-term objectives will be tailored to individual member states based on their current debt ratio and potential growth. This will vary from -1% of GDP for low debt/high potential growth countries to balance or surplus for high debt/low growth countries. Reliability of statistics provided by member states :The Council wants to beef up Eurostat's resources, powers, independence and accountability. As a reaction to the Greek underreporting of statistics, it says that imposing sanctions on a member state "should be considered" when there is infringement of the obligations to duly report government data. The Commission unveiled a proposal to improve the reliable reporting of statistics on 22 December 2004. Involvement of national parliaments in the process Member states' governments have been called on to present stability/convergence programs and Council opinions on these to their national parliaments. Debate concerning the Stability and Growth Pact has continued after the reform, also. Some are of the opinion that the pact has been politicized and is now unlikely to bite at least in the case of the big countries. Or that the reform was a regrettable backward step for European currency stability. Others are very pleased with the new pact, especially Germany, France or Italy. Italian Prime Minister, Silvio Berlusconi noted that "all the governments think that the flexibility allows them to carry out costly but necessary reforms for the future". Germanys Finance 55

Minister, Hans Eichel spoke of a new start and said that Europes credibility hinged on closer cooperation between ministers, Commission and the ECB.

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CHAPTER VI. COMPETITION LAW AND POLICY IN THE EUROPEAN UNION

1. Foundations The competition law of the EU responded to Europes mid-century economic conditions. Its development, driven by the imperative of market integration, profited from the symbiosis between the protection of competition and the promotion of open trade. Decisions of the European Court of Justice (ECJ), pursuing the goals of strengthening the community and eliminating trade barriers, established the legal framework underpinning an ambitious Community competition policy. The European Commissions Competition Directorate (DG Comp, formerly DGIV) is in a nearly unique position in the European Community system, because in the area of competition policy the Commission can apply direct enforcement power that is not dependent on national governments. Community competition law is undergoing a profound transition, after moving beyond the initial goals of opening markets and establishing a competition culture to become a mature, comprehensive enforcement structure centred on the European Commission. The substantive principles that the Community institutions developed have now become a common legal framework shared with the national laws of the Member States. In the future, the law will evolve within the network of national and Community agencies that share responsibility for applying it. The principal focus of this study is the European Commission, as the administrative organ of the 25-country European Union. Most of the discussion would also apply in the context of the EEA, with its 3 additional countries and closely co-ordinated competition policy and enforcement.

1.1 Context and history In post-war Europe, administered economies faced development needs and state monopolies. The institutions of the European Union were created in a context of state intervention through ownership and control over trade and prices, as Europe was rebuilding after depression and war. The designers of the new post-war political economy framework, seeking to expand and integrate markets and sustain development, concluded that competition policy would be a necessary element of the new structure, principally to curb abuses of national monopolies. The concepts and institutions of EU competition law appeared first in the European Coal and Steel Community (ECSC). The need to stabilise Germanys post-war economy and integrate it 57

into western Europe, while preventing German firms from dominating markets, was most evident in the key coal and steel sectors. A new legal entity, the ECSC, was created by the 1951 Treaty of Paris to administer these sectors. The ECSC included most of the elements that were later incorporated into EU competition policy. The competition rules in the Treaty of Rome build on those of the ECSC about agreements, dominance and subsidies, though not the ones about merger control. The rules for the Common Market add some precision to the prohibition of restrictive agreements, while strengthening rule against abuse of dominance into a prohibition. The Council gave the Commission broad powers to develop and apply the law. The Member States did not focus on competition policy very much during the 4 years it took to prepare the regulation to implement the Treaty rules, and thus the Commission ended up with more autonomy in this area than it might haveotherwise. (Goyder, 1998). The 1962 enforcement regulation centralised responsibility in the Commission. Its approach to cartels emphasised the Treatys prohibition, because obtaining an exemption required a decision from the enforcer. Between 1957 and 1962, some national agencies had begun to apply the Treaty provisions. But the Council enforcement regulation marginalised the national agencies and courts by giving the Commission priority in investigations under Community law and exclusive competence over the key subject of exemptions. The Commission had to consult about enforcement actions with a committee of representatives from the Member States, but the committees views were advisory, not binding. The Council rejected a proposal to give this committee veto power. When the system was implemented in 1962, the Commission received over 35,000 notifications requesting exemption or negative clearance. Case-by-case response proved impossible; general rules were obviously needed instead. The block exemption regulation of 1965 responded to the overload, while underscoring the Commissions autonomy in competition policy. The Council delegated authority to the Commission to issue regulations setting generally applicable objective standards for exemption from the cartel prohibition. The Council has not delegated such authority to issue regulations to the Commission for any other substantive field. With encouragement from the judiciary, competition law framed an economic constitution. In the process of decision and appeal during the first decades of Community 58

competition law enforcement, the dialogue between the Commission and the ECJ set the direction and scope of competition policy. Increasing confidence in EU competition policy culminated in the 1989 merger regulation, completing the European competition-policy toolkit. After 20 years of laying the foundation, by the 1980s the Commission was taking stronger enforcement actions. The single-market program and the Single European Act of 1986 reinforced the market-integration objective and thus provided additional momentum for active competition policy. Merger control, which the drafters deliberately omitted from the 1957 Treaty, was finally adopted by a Council regulation after 17 years of effort. Business supported this move to establish a single point in Europe for regulation of large-scale mergers. Implementation involved a process of adjustment. The first time the Commission prohibited a merger, in 1991, governments where the firms were located protested. It took some time to overcome the early impression that political factors could play a role in Commission merger actions. (Gerber, 1998) Wielding this significant power to affect key business decisions bolstered the visibility and prestige of Commission competition enforcement generally. State interventions and monopolies drew increasing attention. Community competition policy is now being reshaped in terms of economic principle. In this project, which has been underway since the mid-1990s, the Commission is building on the increasing reliance on economic reasoning and analysis demanded by merger control and the liberalisation program. With the market integration goal largely accomplished concerning industry and trade, attention shifted both to the constraints on trade in services and to the standard competition policy fare of cartels and monopolies. The shift in enforcement focus entailed a shift in analysis away from formal categorisation. The foundation for the economic reconstruction was laid in the 1997 guideline about the definition of a relevant market. The first major substantive projects were the complete revisions of the rules about vertical and horizontal restraints, replacing long listings of specific requirements and prohibitions with general principles and market-share tests. The Commission is reformulating regulations and revising guidance to modernise Community competition law along these lines.

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Closer judicial oversight led the Commission to improve its internal procedures. Addition of the new Court of First Instance (CFI) in 1989, which doubled the capacity of the Communitys judiciary, provided a more practical avenue for parties to appeal Commission decisions. The Community courts remain supportive of the Commissions competition policy initiatives. But the CFI has rejected Commission actions for procedural errors and for defects in the quality of its reasoning and its treatment of evidence. In 2002, the CFI rejected three Commission merger decisions within 4 months, in opinions that sharply criticised the Commissions economic analysis and its treatment of evidence. Partly in response to problems that these decisions revealed, DG Comp created a new special economic unit and accelerated the recruitment of industrial economists generally in order to increase its capacity for economic analysis, and it introduced additional quality-control checks into its processes of investigation and case evaluation. After 40 years of experience, in 2004 the Community implemented a modernised enforcement process. By removing the Commissions monopoly on deciding about exemptions, the new system makes it much more practical to apply the law through national institutions and processes. The founding treaty envisioned enforcement co-operation between the Commission and Member State national authorities, at least as a transition measure. But of the original six, only Germany had a similarly ambitious competition law system at that time. Now, all of the Member States have competition laws and enforcement agencies, and their national substantive laws have generally converged on the Community standards. Some areas of divergence remain, and the new enforcement regulation deals with the questions of co-existence and supremacy. National law can be applied to conduct that meets the jurisdictional test concerning effect on trade between Member States, but the national authorities must also apply Community law at the same time, and national law cannot prohibit restrictive agreements that would not violate the Treaty. But national law can be stricter than Community law concerning unilateral behaviour.

1.2 Policy goals The Treaty makes competition a principal goal, but it does not elaborate what the concept means. The activities prescribed for the Community institutions include several that directly implicate competition policy: to provide an internal market characterised by the abolition, as 60

between Member States, of obstacles to the free movement of goods, persons, services and capital, and a system ensuring that competition in the internal market is not distorted. (Article 3) The Community and its Member States are to adopt a co-ordinated economic policy based on an open market economy with free competition. (Article 4) These parts of the Treaty thus set out the goal of free and undistorted competition for the Communitys internal market. The basic rules of Articles 81-87 do not limit the choice of policy goals. They do make clear that the competition rules address government measures as well as private conduct. The Treatys opening statement implies that the most fundamental objective of the Community can be understood as promotion of economic welfare and progress, with competition policy being one of several instruments for that purpose. Thus the Treaty text also includes policy goals that might be construed as inconsistent with promoting competition although they are typically phrased in a way that implies there will be no need to choose. For example, Community institutions are to support industry competitiveness, in part by encouraging an environment favourable to cooperation; however, this provision is not to be taken as a basis for any Community measure that could lead to adistortion of competition. (Article 157) The goal of promoting market integration was important when the common market was still being established. Where industries were traditionally established within national markets, the challenge was to get them to transcend those boundaries. The market integration goal explains the emphasis on vertical relationships and intellectual property rights, which were seen as obstacles to crossborder trade. That goal was the link in the Commissions partnership with the ECJ. The Treatys competition rules address conduct that may affect trade between the Member States. If an agreement as a whole is capable of affecting trade, Community law applies to all of it, including parts that individually do not affect trade, and to all of the parties, including ones whose individual contribution to that effect would be insignificant. The jurisdictional test can be met based on the expected effects of potential competition and on positive as well as negative changes in patterns of trade. The further requirement that the effect be appreciable limits this broad scope, though. The EU Guidelines define what is not considered appreciable based on cumulative thresholds of market share (5%) and aggregate turnover 61

(EUR 40 million). In general, these levels define a rebuttable negative presumption. Below those levels, the enforcer has the burden of showing that there is nonetheless an appreciable effect on trade in order to establish Community law jurisdiction over an agreement or practice. For agreements that by their very nature would affect trade, though, each threshold establishes a positive rebuttable presumption: above those levels, parties to such agreements have the burden of showing that there is nonetheless no appreciable effect on trade in order to avoid Community law jurisdiction. Virtually any agreement that controls imports or exports or that is implemented in more than one Member State would be covered by the positive presumption. There is also a clear presumption that an agreement or practice that covers all of a Member State meets the affecting trade requirement, because a cartel or abusive practice of such wide scope would necessarily affect the competitive prospects of potential competitors from outside. More judgment is called for in dealing with agreements or practices that apply only in a part of a single Member State. Community law applies to entities that are undertakings, determined by function. This defined term is interpreted broadly, based on the nature of activities rather than formal structure. It excludes the sovereign functions of a state, but it includes the states commercial activities. It thus includes state bodies engaged in commerce, nationalised industries, municipalities, trade associations, private individuals, co-operatives and associations. Economic activity, not profit, is the important element. Some close cases have involved social insurance funds. Factors that may lead to finding that such a fund is not an undertaking include whether it is compulsory and motivated by solidarity or redistribution. On the other hand, it is more likely to be considered an undertaking if it is potentially in competition with similar private-business entities. A standard analysis for defining markets is used for the tests based on market power. The Commissions 1997 Notice on the definition of the relevant market for the purposes of Community competition law lays out systematically the considerations used to identify product and geographic markets. Legal criteria come from the enforcement and merger regulations. A relevant product market comprises all those products or services which are regarded as interchangeable or substitutable by the consumer, by reason of the products characteristics, their prices and their intended use. The relevant geographic market 62

comprises the area in which the undertakings concerned are involved in the supply and demand of products or services, in which the conditions of competition are sufficiently homogeneous and which can be distinguished from neighbouring areas because the conditions of competition are appreciably different in those areas. The method relies principally on demand substitutability, which is described as the most immediate and effective disciplinary force on the suppliers of a given product. This is tested by examining the markets likely reaction to a 5-10% permanent relative price increase. Supply substitutability may also be taken into account where its effects are equivalent to those of demand substitution. Potential competition is not taken into account when defining markets, but may be considered in the competitive assessment. The guidance recognises that the market definition analysis might depend on the nature of the competition issue under examination. The focus in merger cases is prospective, anticipating market conditions in the future. By contrast, in dealing with restraints or abuse of dominance, the focus could be on present or past conditions, and it could include an examination of whether the conduct has affected conditions in the market and thus the evidence used to define it. Anticompetitive agreements are prohibited and void, unless exempted. Article 81(1) prohibits agreements that have the object or effect of preventing, restricting, or distorting competition. The prohibition extends to decisions by trade associations and to concerted practices. These terms are interpreted broadly, to include arrangements that are not legally enforceable contracts. The alternative characterisations, about the nature of the object or of the effect, also invite broad interpretation. But there are limits: for example, a suppliers arrangements with its customers may not be treated as a set of agreements if the customers had not acquiesced in the suppliers program. Small-scale agreements are not usually considered to be likely to affect competition. In a series of Notices issued since 1970, the Commission has limited the scope of the Article 81 prohibition by describing transactions that are likely to be too small to have appreciable effects. The latest such de minimis Notice sets thresholds based on market share at 10% for agreements between competitors and 15% for agreements between non-competitors. Where there are parallel networks of similar agreements in a market, the threshold is lower, at 5%. The Notice also implies a collective threshold for that situation, stating that cumulative foreclosure is unlikely if less than 30% of the market is tied up in such parallel networks. 63

Regardless of market share, hard-core agreements cannot benefit from de minimis treatment. The Notices definitions of such hard-core agreements are the same ones used in the block exemption regulations and guidelines about vertical and horizontal agreements. The rationale for de minimis treatment is that competition concerns are unlikely if companies do not have a minimum degree of market power. Economic benefits from an agreement can lead to exemption from the prohibition. Under Article 81(3), an agreement that would otherwise be prohibited may nonetheless be permitted, if it improves production or distribution or promotes technical or economic progress and allows consumers a fair share of the benefit, imposes only such restrictions as are indispensable to attaining the beneficial objectives, and does not permit the elimination of competition for a substantial part of the products in question. Improvements in productive efficiency obviously can be considered. Promoting progress could also include prospects for innovation that may be less immediately tangible. Neither efficiency nor progress implies a broad social balancing of economic advantages and disadvantages. Goals pursued by other Treaty provisions can be taken into account to the extent that they can be subsumed under the four conditions of Article 81(3). Guidelines from the Commission acknowledge that applying the 2 parts of Article 81 is a balancing process, seeking to identify the net economic effect of the restriction and the efficiencies. An increase in market power increases firms ability and incentive to raise price, but cost efficiencies may permit them to reduce price. In balancing these potentially opposite effects, the requirement that benefits be passed on to consumers results in a sliding scale.

2.2 Horizontal agreements The Treaty specifies some of the horizontal agreements it prohibits. The listing, which is not exclusive, includes direct or indirect fixing of prices or trading conditions, limitation or control of production, markets, investment or technical development and sharing of markets or suppliers. Decisions have clarified what else Article 81 prohibits. All forms of agreements to divide markets and control prices, including profit pooling and mark-up agreements and private fair trade practice rules, are prohibited. Exclusionary devices such as aggregate rebate cartels are prohibited even if they make some allowance for dealings with third parties.

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Joint purchasing and selling are permitted in some market conditions. Exchange of price information is permitted only after enough time has passed, and only if the exchange does not permit identification of particular enterprises. Something close to a per se rule can be used against hard-core conduct. It is not necessary to prove that price fixing, market division or output limits or quotas actually raised prices or reduced output. Decisions have made clear that those effects are presumed, and parties to the agreements cannot overcome the presumption by claiming they had no intention or capacity to achieve an anti-competitive effect. The decision to fix prices is enough to establish the infringement. To set the fine, though, factors in addition to the nature of the infringement could also be relevant to showing the gravity of the offence. These factors could include the cartels geographic scope and its impact, if that can be measured. Showing implementation of the cartel agreement would not require evidence of marketplace effect; for example, it would be enough to show that the colluders announced agreed price increases or met to monitor compliance. For hard-core infringements, the ECJ has agreed that factors related to intent may be treated as more significant than those related to effects. Agreements that are tacit or undocumented may be prohibited as anticompetitive concerted practices. This term covers co-operative activity short of explicit agreement, which the ECJ has described as coordination between enterprises, that had not yet reached the point of true contract relationship but which had in practice substituted co-operation for the risks of competition. The term can include hard-core restraints. Cases about concerted practices typically look for evidence of arrangements for reaching and enforcing compliance with implied agreements to limit competition. The Commission has applied the concept to conduct that some other enforcers would treat as ordinary agreements, such as formal industry-wide market-sharing arrangements set up by trade associations. In this role, the term fills a conceptual gap in a legal tradition that privileges documentary formalism. But pure oligopoly interdependence would not be a prohibited concerted practice. Intentional communication and awareness are needed, not just mutual awareness of the benefit of restraint. Because Article 81 explicitly applies to decisions of trade associations, Community law can deal with this common setting for cartel agreements in a straightforward way. There is no need to infer constructive agreements or resort to theories of collective dominance. The decisions that Article 81 prohibits can include an associations formal rules or its more informal actions or recommendations. Where the infringement is attributed to the 65

association, the Commission may nevertheless take into account the sum of the members turnovers in calculating the associations fine. Under some conditions, the members may be liable for the payment of the fine by the association. The Commission will obviously go after the members for their own behaviour. In its application to non-hard core agreements, Article 81 resembles a rule of reason. The Article 81(1) prohibition and the Article 81(3) exemption criteria require market analysis and balancing of positive and negative effects in cases of horizontal co-operation that does not amount to a hard-core cartel. The Commission has issued block exemption regulations about agreements for production specialisation and for research and development, accompanied by guidelines to show how Community law can allow competitor collaboration where it contributes to economic welfare without creating a risk for competition. The case law is not entirely consistent about whether the assessment of market conditions and consideration of potentially competing policies and effects are part of determining whether Article 81(1) prohibits an agreement or of determining whether Article 81(3) exempts it. For non-hard core agreements, the ECJ has said that market conditions, market structure and the economic context determine whether Article 81(1) prohibits it. For a hard-core agreement, those considerations might come up, if at all, only to determine whether efficiency claims under Article 81(3) exempts it. The Commissions Guidelines state that the four conditions for exemption are exhaustive, so no other grounds can be invoked. (Guidelines on the application of Article 81(3), para. 42). Determining under Article 81(1) whether the agreement could restrict competition involves determination of the nature of the agreement, definition of markets, and evaluation of market structure and market power, including considerations such as the nature of the products, market concentration, barriers to entry, stability of shares and the countervailing power of buyers or suppliers. The horizontal guidelines presume that if parties have a low combined market share, co-operation is not likely to restrict competition. The guidelines do not prescribe a single rule, because conditions and effects can vary significantly, but they do suggest particular levels for some kinds of agreement. For agreements about joint purchasing and commercialisation (that is, selling, distribution and promotion), the guidelines set a safe harbour at a combined market share of 15%. High market shares will not necessarily be a concern for standardisation agreements, and the assessment 66

focuses more on whether the standards could raise barriers to entry. No market share test is needed for agreements that, because of their very nature, are unlikely to reduce competition. This could be the case, for example, if the parties could not carry out a project independently at all, or if their agreement is about an activity that does not affect any relevant parameter of competition. At the other extreme, no market share threshold applies to the hardcore restrictions of price-fixing, output limitation and allocation of markets or customers, which are generally prohibited irrespective of the parties market shares.

Cooperation horizontal agreements The guidelines then explain the application of the cumulative Article 81(3) criteria about economic benefits and its caveats about sharing the benefit with consumers, indispensability of the restraint to achieving the benefit and not eliminating competition by dominating the market. The block exemption regulation about specialisation treats production rationalisation in the same way that the guidelines treat similar practices which are not covered by the exemption. For agreements between competitors to specialise production, the regulation sets a market share threshold for exemption at 20% (for all parties combined, and subject to certain conditions, including the absence of hard-core restraints) The block exemption regulation for research and development is generous, particularly to innovation that promises to create new markets. Agreements between competitors about research and development are exempt up to a combined market share of 25% (of the market for the product that is the subject of the joint research), subject to certain conditions and the absence of hard-core restraints. Here too, the guidelines about the application of the block exemption regulation use the same level to presume the lack of effect on competition and to explain why benefits would be presumed to outweigh harm to competition. If the collaboration is developing something for which there is not yet any market, the guidelines recognise that a successful first-mover effort should not necessarily be seen as an elimination of competition, even though it could lead to huge initial market shares once the product is developed. Thus, the block exemption permits such agreements to continue regardless of market share for the first 7 years after the product comes to market. At that point, the safe harbour of 25% applies.

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Enforcement of Article 81 developed in an environment that had tolerated formal industry co-operation, sometimes amounting to self-regulation. Early cartel cases targeted nationalscale industry associations and substantial international agreements about quinine, dyes, aluminium and chemicals. Some cartels had formal committees that kept minutes of their agreements. For other cases, obviously coordinated market actions could support an inference of agreement. Collection and exchange of information about price and output through trade associations has been a concern, as a means of tacit or even explicit co-ordination to confirm and police agreements. By the early 1990s, some cartel cases had resulted in total fines of over EUR 100 million. As the fines for price fixing mounted, Commission enforcement strategy began relying increasingly on insider evidence supplied by firms seeking clemency. This was formalised in the Commissions 1996 leniency notice, publicly announcing what had been an unofficial practice. The level of enforcement against horizontal cartels has sharply increased since 2001. The Commission has issued an average of about 8 decisions per year, compared to fewer than 2 per year over the previous decades. The Commissions notice about setting fines treats hardcore cartels as very serious infringements, for which the fine, determined by gravity, would normally be at least EUR 20 million (before considering other factors). The fines imposed in these recent cases confirm that treatment. In 31 Commission cartel decisions since 2001, the fines totalled EUR 4 billion. The peak was in 2001, with EUR 1 836 million. The level then dipped, and in 2004 the total was about EUR 390 million. Despite the increased activity, the fines being imposed may not yet be enough to deter hard-core infringements.

2.3 Vertical agreements Most restraints in agreements about supply and distribution are permitted, unless there is market power. The 1999 block exemption regulation for vertical cooperation agreements restated the Commissions analysis of these restraints. Recognising that parties typically enter agreements to manage the distribution chain in order to improve efficiency and that smallerscale agreements are unlikely to affect competition either upstream or downstream, the regulation applies a market share screen. It exempts most agreements involving a supplier or buyer with a market share under 30%, considering that to be a level at below which vertical agreements would be expected to lead to an improvement in production or distribution and allow consumers a fair share of the resulting benefits (as long as they do not include certain particularly harmful restraints). 68

The buyers share of its downstream market is considered where the contract requires the supplier to sell exclusively to that buyer. Vertical agreements involving associations of retailers are also exempted, as long as the turnover of each is below EUR 50 million. Where parallel, similar networks of agreements account for more than 50% of a market, the Commission reserves the power to disapply the exemption, on 6 months notice; it has not yet done so, though. There is no presumption of violation where an agreement involves a supplier with a share over 30%. But with increasing market power come increasing concerns that agreements might impair competition, by foreclosing other suppliers, raising barriers to entry or reducing interbrand competition and facilitating collusion. The regulation also notes possible concerns about reducing intrabrand competition and about creating obstacles to market integration. The regulation applies to many types of agreements, replacing previous notices and regulations about topics such as exclusive distribution and franchising. Unlike previous regulations of similar topics, it does not contain a list of permitted clauses, an approach which had tended toward uniformity of practice out of a fear that whatever was not permitted would be prohibited. The vertical block exemption regulation takes the opposite position: below the 30% threshold, whatever is not prohibited is permitted. Fixing minimum resale prices and excessive territorial protection remain blacklisted, regardless of low market share. Resale price maintenance has always been treated as a per se infringement, at least with respect to minimum prices; however, recommending a resale price or requiring resellers to respect a maximum resale price are exempted, up to the 30% market share threshold, provided that the result is not a fixed or minimum sale price due to pressure from, or incentives offered by, the supplier. Territorial resale constraints are suspect, but some are permitted, to protect systems of exclusive dealership, preserve functional distinctions between wholesalers and retailers or prevent resale of components leading to competition with the supplier. The latest regulation followed a series of infringement actions that imposed fines totalling EUR 276 million. At the time (1998), the EUR 102 million fine against Volkswagen was the largest fine the Commission had ever imposed against an anticompetitive restraint. (The CFI later reduced this fine to EUR 90 million.) The experience persuaded the Commission to take a tougher line in this sector than the general vertical restraints regulation. The black list of forbidden clauses is unusually long and detailed. Manufacturers do not benefit from the block exemption if they do not allow their authorised dealers to sell competing brands or if they limit the dealers ability to open secondary outlets in other 69

territories. The regulation applies the same market-share safe-harbour, of 30% (and 40% for a selective distribution system with a limited number of distributors), and it permits suppliers to use an exclusive system, but only if the system imposes no constraints on making passive sales to customers in other areas.

2.4 Abuse of dominance Curbing abuses by firms that dominate markets and suppress competitors or harm consumers is the other main subject of Community antitrust law. Article 82 prohibits the abuse of a dominant position. Some acts that the Treaty lists as abuse are imposing unfair purchase or selling prices or trading conditions (either directly or indirectly), limiting production, markets, or technological development in ways that harm consumers, discrimination that places trading parties at a competitive disadvantage and imposing non-germane contract conditions. Other kinds of conduct by a dominant firm that disadvantage other parties in the market could also be abuses. Practices such as loyalty rebates that would not be objectionable when done by a firm without market power could be considered abuses when done by a firm in a dominant position. To find infringement it is not necessary to show that an abusive practice produced an actual anticompetitive effect; it is enough that the conduct, when undertaken by a dominant firm, tends to restrict competition or is capable of having or likely to have that effect. There is no provision for exemption, although the case law has developed a doctrine that otherwise abusive conduct is not prohibited under Article 82 if it is objectively justified. Dominance is a broader concept than economic market power over price. It is not the same as economic monopoly, although a monopoly would clearly be dominant. Dominance is often presumed at market shares over 50%, and it may be found at lower levels depending on other factors. The ECJs Hoffman-LaRoche (1979) and United Brands (1978) judgments explained the meaning of dominance under the Treaty, describing it as a position of economic strength enjoyed by an undertaking which enables it to prevent effective competition being maintained on the relevant market by affording it the power to behave to an appreciable extent independently of its competitors, its customers and ultimately of the consumers. These still-authoritative judgments found dominance based on features such as vertical integration, because that enabled a firm to act independently of its suppliers of intermediate services, and at market shares of 40-45%. In current practice, there appears to be a safe harbour at a market share of 70

about 25% and a rebuttable presumption of dominance at about 40-50%. Dominance depends on factors other than market share, such as the number and relative size of other firms and the conditions of entry. A finding of dominance is more likely if entry is difficult or if there are no other firms of comparable size or with the capacity to counter the leaders strategies. Article 82 is not limited to single-firm misconduct. Under the theory of collective or joint dominance, several firms can share and abuse a dominant position. When the Commission first tried to apply Article 82 to oligopoly, the Court of First instance rejected the argument (although the court upheld the finding of infringement under Article 81 as a restrictive agreement). To find that several firms together hold a dominant position, the court demanded that the firms be united by economic links, such as a network of interdependent intellectual property licenses. A formal cartel could possess collective dominance. Judgments applying the analogous language about dominance in the Merger Regulation, which have been cited as authority for the application of Article 82, imply that oligopoly interdependence might amount to collective dominance if the members could monitor each other effectively, if retaliation against defectors was credible enough to provide each member with an incentive to maintain coordination and if customer and consumer responses would not undermine co-ordination. Exploitation of market power by charging high prices could be an abuse, although no final decision has actually condemned it. In the 1970s, reviewing Courts annulled 2 Commission decisions that had challenged high prices as abuses. The early Court judgments about abuse of dominance agreed with the principle, though, that unfair pricing could include setting prices to take advantage of market or monopoly power. Prices would be too high if they bore no reasonable relation to the economic value of the product. The ECJ has also endorsed the concept that Article 82 could prohibit prices for licensing intellectual property rights that are particularly high and not justified by the facts. Despite the theoretical support for the sweeping principle, in the end the decisions have declined to fiind infringements based upon the evidence in the cases. For predation, anticompetitive intent can be inferred from prices too low to recover costs; the strength of the inference depends on the cost reference. Prices below average variable cost are presumed to be predatory, that is, intended to eliminate competitors. Prices above that level

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that do not recover total costs may also be treated as predatory, but that conclusion may depend on further evidence of the intent to eliminate or prevent competition. Discrimination is included among the abuses listed in the Treaty text, which prohibits putting other parties at a competitive disadvantage through the application of dissimilar conditions to equivalent transactions. This language implies some common principles of competition laws about discrimination, notably that the discrimination must be between transactions involving the same product or service and that it must actually cause competitive harm. The harm could be to an individual competitor, though, and not necessarily to competitive conditions in the market. Price variations that correspond to different national markets have been treated as prohibited discriminations, in the absence of objective justification in terms of differences in costs or in the extent of the sellers exposure to different risks in different markets. Decisions have prohibited discriminations about inputs that impose a price squeeze on non-integrated competitors or that unfairly favour national-champion incumbents. Putting pressure on customers to enter into requirements contracts can be an abuse. Many cases have dealt with the foreclosure effects of loyalty rebates. Loyalty programs may be permitted if they are based on cost efficiencies. Only cost savings to the supplier can justify quantity-based rebates. Indeed, recent decisions imply that the only way to avoid liability is to base the loyalty scheme strictly on cost differences. Refusal to supply a customer can be an abuse, particularly if the customer is a long-time regular trading partner, but a reasonable justification, such as the customers poor credit, can overcome the prohibition. The prohibition of tying is implied in the Treaty text, which prohibits imposing non-germane conditions in contracts. The elements of tying, or refusing to supply a product unless the customer also takes another, allegedly unnecessary one, are dominance in the tying product, a separate tied product, coercion to take them together, an anti-competitive effect in the market for the tied product and the absence of an objective, proportionate justification for the tie. Bundling, which can make the price of the tied product effectively 0, can be construed as coercion. The most prominent application of Article 82 to tying tactics is the Commissions 2004 action against Microsoft. Refusal to licence intellectual property, under some circumstances, can violate Article 82. The leading case reaching this result emphasised that the refusal prevented the production and marketing of a new product for which there was a potential consumer demand. The ECJ later 72

refined the conditions for finding liability. The firm seeking the license must not be intending essentially to duplicate what the owner of the right already offers, there must be a potential consumer demand for the firms product, the refusal to license must not be justified by objective considerations; and the refusal must prevent, to the detriment of consumers, the development of a market in which the licence is an indispensable input. A wide range of remedies is available to correct and deter abuse of dominance. The new enforcement regulation has authorised the Commission to order structural relief, which could include divestiture but might also include other dispositions of property rights. These measures must be proportionate. The Commission may only use structural measures to correct abuse of dominance where there is no equally effective behavioural remedy, or any behavioural remedy would be more burdensome to the entity that will be the object of the structural remedy. The new enforcement regulation also confirmed that the Commission can order interim relief, which is particularly significant in cases about access. Behavioural orders and financial sanctions remain the principal tools. Substantial recent fines include EUR 13 million for exclusionary pricing in telecoms and EUR 24 million for loyalty rebates. The fine against Microsoft shows that Community sanctions against abuse of dominance can be vigorous; at EUR 497 million, it exceeds the total fines the Commission imposed against horizontal cartels in 2004.

2.5 Mergers The inclusive legal standard for merger control can deal with all kinds of competitive effects. The Commission may prevent or correct a merger that would significantly impede effective competition in particular as a result of the creation or strengthening of a dominant position. This substantive standard is subsidiary to the Regulations fundamental criterion, whether the transaction is compatible with the common market. The 2004 revision of the Merger Regulation revised the original 1989 standard. The principal issue motivating the change was non-coordinated effects in oligopoly markets, where the merged firm might have market power without necessarily having an appreciably larger market share than the next competitor. The guidelines presume that a merger does not impede effective competition if the new entitys market share would not exceed 25%; however, this presumption does not apply to coordinated effects, where the merged entity would be collectively dominant along with other 73

third parties. Regardless of these levels, though, the guidelines warn that special attention will be paid if any party has a pre-merger share over 50%, or if there are obvious issues of potential or toe-hold entry, innovation, cross-shareholding, maverick market behaviour or indications of oligopoly behaviour in the industry. The guidelines discuss in detail the theories of non-coordinated and co-ordinated anti-competitive effect. Where non-coordinated effects are the concern, an important indicator where products are differentiated can be the closeness of substitution between the merging firms products, for homogeneous products, an important factor is the relative capacities of the merging firms and their rivals. A market share over 50% and a significant market share advantage over any rival may be a strong indication that the merger would create or strengthen a dominant position. Where co-ordinated effects are the concern, the guidelines describe the conditions for finding that a merger will create or strengthen a position of collective dominance. Countervailing factors include buyer power and entry. Whether significant entry is likely is determined by inquiring whether an entrant would find it profitable to do so in postacquisition market conditions. Entry must not only be likely but also sufficient and timely. The measure of timeliness could vary in different product markets, but the normal test is 2 years. Efficiencies can also be a mitigating factor, if they are merger specific, timely, verifiable, and benefit consumers. Reductions in variable or marginal costs are more likely to lead to lower prices, and hence they would get more weight than savings in fixed costs. The guidelines disavow an efficiency offence, that is, that increases in productive efficiency, giving the merged firm a cost advantage over rivals, will be a reason to reject a merger. If one of the parties is financially failing, the guidelines would permit an otherwise anticompetitive merger. The rationale is that the competitive structure would deteriorate equally absent the merger. The parties must show that the allegedly failing firm would in the near future be forced out of the market by financial difficulties if not taken over by another firm, that there is no less anticompetitive alternative acquirer, and that in the absence of a merger the assets of the failing firm would inevitably exit the market. The merger regulation and the guidelines do not call for considering policies other than effects on competition. Efficiencies are taken into account as part of the competitive assessment. Member States could invoke these principles to block or regulate transactions that

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do not impede competition; however, they could not invoke them to authorise a transaction that the Commission has blocked. A concentration cannot be put into effect before it is notified to the Commission and the Commission has cleared it. This merger control power applies only to transactions that are large enough to have a Community dimension. That status and the associated obligation to notify the Commission in advance are defined in terms of turnover, in total and within the Community. A transaction has a Community dimension when the combined aggregate worldwide annual turnover of all of the firms involved is more than EUR 5 billion, and the aggregate turnover within the EEA of each of (at least two) of them is more than EUR 250 million. An alternative definition captures certain transactions that have significant effects in several Member States. If the merging firms concentrate their Community business in a single Member State (with each of them having more than two-thirds of its Community turnover there), then the merger does not have Community dimension and the national competition authorities are responsible for it. There is also now a discretionary process for avoiding multiple national filings and reviews. If a merger may have to be reviewed in 3 or more Member States, the merging firms can request that the Commission examine the merger, which it will do if none of the Member States objects. Merger control is more like a formal approval than a simple notification. The merger regulation, the Commissions implementing regulation and its best practice guidelines set out the process. It begins with informal contacts with DG Comp staff, including submission of a briefing memorandum and draft notification documents, before any formal filing is made. The formal process begins with submission of a detailed notification describing the transaction, its motivations, markets affected, market shares, and conditions of supply, entry and exit, and considerable other documentation. The Commission may use all of its other powers to get further information from the merging parties and from others. The Commissions decision process for mergers is similar to the process for other competition matters, except that merger decisions are subject to strict deadlines. The deadlines are now set in terms of working days. In the first phase, the issue is whether to clear the transaction or to open a second phase investigation; the deadline to finish the first phase is 25 days; if the matter continues to the second phase investigation and decision, the deadline is 90 days from the beginning of the second phase; if the parties offer modifications to deal with competition concerns, the first phase can be extended to 35 days, and the second phase, to 105 days. 75

3. Institutional issues: enforcement structure and practices The administrative process for applying the law is adapting to strengthen investigative powers and better incorporate economic concepts and evidence in decision-making, in order to convince the courts while maintaining policy consistency in a system of decentralised enforcement.

3.1 Competition policy institutions The European Commission, as the Communitys executive body, implements its competition policy. By Treaty, the Commissioners shall, in the general interest of the Community, be completely independent in the performance of their duties, neither seeking nor taking instructions from a government or anyone else, and refraining from any action incompatible with their duties. Member governments undertake to respect the principle and not to seek to influence members. In the Commission staff, the Directorate-General for Competition is principally responsible for competition policy and enforcement. Headed by a Director General who is a career Community manager, DG Comp is organised into 10 directorates, for management, antitrust and merger policy, cartel enforcement, sectoral expertise (4 directorates) and state aid (3 directorates, including one for policy). DG Comps complement has been stable for several years at just over 600 permanent staff. In addition, DG Comp relies on contract and auxiliary personnel and experts seconded from Member State competition agencies.

3.2 Enforcement processes and powers The Commission uses broadly similar basic procedures and investigative tools for dealing ex post with infringements of Articles 81 and 82 and for decisions about notified mergers. A complaint or merger notification, or a decision to start a procedure at the Commissions own initiative, is followed by an investigation by DG Comp, managed by a case handler. The evidence and proposed remedy are presented to the respondent in a statement of objections. The respondent has a right of access to the investigative file and an opportunity to reply, in writing and at an oral hearing. The decision is taken by the Commission, on a recommendation of the Competition Commissioner. The Commission no longer processes applications for individual exemption or negative clearance, because it no longer has the power to issue them. The enforcement regulation provides for the possibility of a guidance letter, but it sets conditions to discourage routine requests. Now that the historically

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important system of notification and exemption has been eliminated, the legal criteria describing what is prohibited and what qualifies for exemption apply directly. In effect, this approach puts a burden on companies to evaluate their agreements accurately, as they are at risk for making a mistake. A complaint is submitted on a prescribed form. Comprehensive background information and documentation are required. The complainant is asked to detail the factual basis of the claim, supply information about markets and market shares, submit documents and statistics relating to the complaint, give names of persons who could testify about it, explain the complainants legitimate interest in the matter and specify the relief sought. Investigative tools and powers deal principally with documentary information, since Commission procedures rely heavily on documentary evidence. A request for information may be a simple request or a request by decision. Each will state the basis and purpose of the request, specify the information requested and the deadline, and indicate the consequences of incorrect or misleading response. There is no penalty for failing to respond to a simple request, although a company can be fined if its responses are false or misleading; by contrast, a company risks substantial fines for failure to respond to a request by decision. The Commission now has a limited additional power to interview persons during investigations. Providing false or misleading information in an investigation, or failing to provide complete and accurate responses within the time set by a request by decision, may result in fines of to 1% of turnover. Daily periodic penalties of up to 5% of average daily turnover may also be imposed to compel complete and accurate responses to a request by decision. Advisory Committees composed of officials from Member State competition agencies play a role in both antitrust and merger matters. These committees meet regularly and submit opinions about proposed decisions. Their opinions about mergers are appended to the decision and published. Their opinions about other cases are appended to the decisions and may be published if the Committee recommends it. Advisory Committee views do not control DG Comps recommendation to the Commission. But the consultation process is a valuable avenue for achieving general consensus, and DG Comp takes the views seriously.

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The draft decision is prepared by the DG Comp case-handler (or team of casehandlers) and reviewed by DG Comp management. It is also reviewed by the decision scrutiny unit. The Competition Commissioner consults with the Legal Service and the Advisory Committee from the Member States before proposing a decision to the Commission. There are several other means for providing a measure of quality control over the staffs recommendation, in addition to the possibility of n internal scrutiny panel.

Application of fines and sanctions The principal sanction for substantive infringements, set out in the Council regulation on enforcement, is an administrative fine against the infringing undertaking. This fine can be as high as 10% of the undertakings global annual turnover. The regulation does not authorise fines against individuals. The process begins with a basic amount, which is then adjusted upwards for aggravating circumstances and downwards for attenuating circumstances. The basic amount depends on the gravity of the infringement (which includes its nature and impact (if measurable) and the size of the market) and its duration. The guideline recognises three classifications in terms of the gravity of the infringement: minor, calling for a fine between EUR 1 000 and EUR 1 million; serious, up to EUR 20 million; and very serious, over EUR 20 million. These approximate levels are not fixed. That amount can then be increased to account for duration, up to 50% for medium duration infringements and up to 10% per year for longer ones. The aggravating circumstances could include repeat offences, refusal to co-operate, leadership in the violation, retaliation against other firms and the need to set the penalty greater than the gain. The attenuating circumstances could include with a passive role in the violation, non-implementation, termination upon Commission intervention, reasonable doubt about whether the conduct was an infringement, negligence and co-operation with the Commission (outside of the leniency programme). The enforcement regulation now makes clear that the Commission can accept binding commitments to correct infringements and that the Commission can impose a fine for failure to comply with these commitments; however, commitments are not to be accepted in cases where the Commission intended to impose a fine in the first place.

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The Commission has had a formal leniency program since 1996. The first undertaking that comes forward can receive full immunity from fines. If immunity has already been granted, or if the Commission already has enough evidence to find an infringement, reductions of fines remain possible for companies that provide significant added value to the Commissions case. For the second firm to come in, the fine could be reduced by 30-50%; for the third, 20-30%; for others, no more than 20%. There are conditions: the applicant must co-operate throughout the Commissions proceeding and end its involvement in the cartel, and it may not have coerced others to participate in the violation. Applications continue to increase. There were 16 in 2003 and 29 in 2004.

3.3 Judicial review Commission decisions are subject to oversight by the two European courts. The ECJ, which was established in the original ECSC, ensures enforcement against Member States, decides disputes between the Community and Member States (and between Community institutions) and ensures uniform interpretation of Community law by deciding questions referred to it by national courts. The CFI was created to reduce the ECJ workload and backlog by dealing with the cases with no political or constitutional importance and those involving complex facts. The ECJ can review CFI judgments, but only on matters of law.

3.4 Other means of applying EU competition law Private parties can sue in national courts, under national procedures, for relief from infringements of Community competition law. The usual Commission infringement proceeding has elements of privately-initiated litigation. An advantage of taking the trouble to meet the demands of a formal complaint at the Commission is that complainant gains party standing, including the right to participate to some extent in the proceedings at the Commission and to seek judicial review if the action is unfavourable. The Commission has long tried to encourage resort to private suits in national courts and issued a notice on co-operation with national courts to call attention to the option and provide guidance. Notably, national judiciaries must make available to claimants under Community competition law all remedies and procedures, such as injunctions and compensation, that are available to claimants under analogous or related national laws. DG Comp is again trying to

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promote more private enforcement, to empower those who are the object of infringements of the law. Member State competition agencies and courts can apply Community substantive law. All Member States have taken the necessary national legislative steps to be sure that national institutions have the power to apply Community law. Indeed, national authorities now have an obligation to apply Community law if the jurisdictional requirement of Community effect is met. National authorities can, under Community law, order cessation of an infringement, order interim measures, accept commitments, impose fines and make negative determinations that there are no grounds for action. The informal European Competition Network (ECN) is the medium for facilitating interagency co-ordination. The ECN is conceptually and functionally distinct from the Advisory Committee that must be consulted about Commission enforcement proposals. It is also distinct from the association of European national competition agencies, which has been in existence for several years (and which includes agencies in countries that are not Member States of the EU). The basis for the ECN is in the enforcement regulation requirements for consultation and provisions about information exchange and case allocation. The network is mentioned in the recitals of the enforcement regulation, but the ECN has no legal status. The notice on co-operation explains how it will work, to allocate cases, handle information and ensure consistency. A joint declaration in the modernisation package describes the agencies non-binding expectations about co-operation. Normally, a case would be handled by the authority of the Member State that is most affected, and others would stay their own proceedings. The Commission would normally deal with matters that substantially affect more than 3 Members or where its intervention is appropriate in order to ensure efficient enforcement or to set policy. Where a national authority is already acting on a case, the Commission would only exercise its power to take over if it looks like it will be in conflict with others or with established Community case law, if it is taking too long, or if similar problems are appearing widely and a Community decision is needed to clarify Community policy. The Commission would not normally adopt a decision in conflict with a national authoritys decision if it has been kept fully informed about the case. The ECN is also 80

a forum for informal co-operation. The members hold occasional plenary meetings at the policy level. There are also working groups on topics such as leniency, transitional issues, sanctions and procedures, and Article 82, and sector subgroups about railways, electricity and insurance. As agencies across the Community share enforcement responsibilities, complications will arise about parallel investigations and leniency applications in several jurisdictions. Exchange of experiences has led to the introduction of generally consistent leniency programs in the Member States. Programs are in place in 17 Members now, and programs are planned in several more. Enforcement could suffer it multiplicity and inconsistency deter firms from coming forward. Differences among the programs are few, mostly about the obligation to stop the infringing conduct.

4. Limits of competition policy: exclusions and sectoral regimes There is no general principle in the Treaties or in Community jurisprudence about how to deal with a conflict between the demands of competition law and those of other Community-level laws or official actions. Conflicts with Member States laws and official actions have been a much more important topic. The Member States capacity to use national law to prevent or restrain competition is limited. A Member State may constrain the freedom to set prices, if this is manifestly an exercise of government authority and not rubberstamping of a private agreement and if the power has not been removed by Community legislation. But business firms cannot usually defend their infringements of Article 81 or Article 82 by claiming that national regulation eliminated their freedom of competitive action. Member States may adopt rules that constrain competition in order to promote some sectoral or other policy, as long as there was no contrary Community policy on the issue and other Treaty obligations are respected. Since those other Treaty obligations include market openness and non-discrimination, national measures that might affect trade would not be permitted. But the Treaty texts combine to disfavour a broad state-action exemption. Article 10 of the Treaty obliges Member States to take all appropriate measures to fulfil their obligations and to facilitate the Commissions task, and it requires that they abstain from any measures that could jeopardise attainment of Treaty objectives. One of those objectives is a system ensuring that competition in the internal market is not distorted. (Article 3(1)(g))

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Labour is not subject to Community competition law. The Treaty covers labour separately, in Article 39. Employees are not undertakings; rather, they work for undertakings. Trade unions would be considered undertakings to the extent that they enter into commercial activities, but not when they are dealing with labour market issues. In general, agreements concluded in good faith on core subjects of collective bargaining, such as wages and working conditions, which do not directly affect third markets and third parties are beyond the scope of Community competition law.

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CHAPTER VII. THE PROCESS OF THE ENLARGEMENT OF THE EU

Determining factors Careful scrutiny of preceding EU enlargements and the processes involved has shown that there are five factors that have always played a important role and that the course and outcome of these factors have been a huge influence on the whole process. We want to use this knowledge to create a small model designed to help us to understand the enlargement process better. One of the first determining factors is the contractual basis, that is, the internal EU rules that are used to determine how the enlargement process should proceed in detail. When it comes to making an enlargement decision, for example, it is is important to remember that it makes a large difference whether unanimity has to be reached or whether a majority of votes will suffice and whose agreement is needed. Although the contracts have always contained rules on enlargement, it would be quite wrong to get the impression that the EEC, EC and now the EU and their member states have always been working tirelessly and continually towards expanding its membership numbers. The reason for this is clearly to be found in concerns held by the existing members that expanding the membership would lead to more heterogeneity and make cooperation considerably more difficult. Indeed, it is for this very reason that discussions about new applications have always been set against the question as to how far enlargement would have a negative effect on progress toward further integration. This tension between enlargement on one side and closer cooperation (deepening) on the other forms the second determining factor for our model. Having said this, however, previous European expansions make it very clear indeed that decisions on whether to admit new members have never been solely based on objective considerations between enlargement on the one side and deepening of the integration process on the other. No, the position adopted by existing members has always been dependent on three other core aspects or issues:

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The first of these factors is the special interests held by member states in individual areas, such as real fears that certain areas of a national economy could be placed at a competitive disadvantage because of more competitive products coming from new member states. Agriculture is a good case in point when thinking back to the resistance demonstrated by France against enlargement to the south. National interests are another factor, that is, that enlargement can limit the possibilities of individual member states to influence the decision-making process. An example of this reflected in the issue of how voting should be weighted in the Council. The last factor is fears held by member states and all other players such as the Commission and the European Parliament as to what degree enlargement might impact on the ability of the EU system to make decisions.

I. Enlargement to the NORTH The first phase of expansion that we will be looking at is enlargement to the north. The UK's first application was made in 1961, only four years after the Treaty of Rome had come into force. Eleven years would pass, however, before Great Britain, Denmark and Ireland were finally able to join. But what were the reasons for this? One of the biggest stumbling blocks was the determined resistance displayed by the French President, de Gaulle. While economic motives might also have played a part, the main reasons for this resistance were political and above all the fear that by allowing Great Britain - a country with a "special" relationship to the USA" - to become a member of the Community, the United States would be able to influence the development of the Community. This stood in stark contrast to de Gaulle's fundamental belief that the EC should be structured as cooperation between sovereign states independent of American influence.

In contrast, other member states and the Commission thought that membership of the U.K. would offer a welcome counterbalance to French dominance. In other words: The position of member states was characterised by their basic attitudes to the future direction of EC development. The potential membership of the U.K. was viewed as something that could

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either strengthen or weaken the individual position of member states and not as a complex of problems in its own right. Over the long-term, however, France was unable to prevent expansion. De Gaulle's successor, Georges Pompidou, agreed to restart negotiations at The Hague Summit Meeting in 1969. One of the most decisive factors for this agreement was that it was possible to take the interests of all member states into account as part of a large package deal. In return for France's consent to enlargement, the package deal included the agreement of all other member states to complete and further expand the scope of the Common Agricultural Policy. This means that extraordinarily important sectorial interests were at stake. All the same, Great Britain and Denmark clearly held a totally different view on what the role of the Community should be. They both regarded the EC primarily as an economic community, from which they hoped to achieve economical benefit. Both countries were totally against allowing any further erosion of national sovereignty. In both countries the very membership of the EC represented an issue on which public opinion was deeply divided. Indeed, it was mainly this situation - set against the need to reach unanimous decisions - that was responsible for the series of crises and stagnation in the Community's development during the 70s and at the beginning of the 80s.

II. Enlargement to the South While the desirability of British membership was being called into question, the membership of Greece, Spain and Portugal, otherwise known as the enlargement to the south, was, for politically strategic reasons, regarded unanimously as a positive and necessary move. Concerns were being raised, however, as to the possible economic and institutional consequences of the expansion south. The level of economic development of all three countries was considerably lower than the Community average; in addition to this, it was feared that three more members would mean increased heterogeneity. This coupled with a significant increase in its membership, led many people to believe that the efficiency of the institutions and the decision-making processes would be impaired.

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The biggest influence on the expansion south was caused by internal difficulties within the Community at the beginning of the 80s. In reality the arguments were really about fundamental differences over the direction of future integration. These problems caused accession negotiations to be delayed on numerous occasions and it was not until 1984 and the Summit in Fontainebleau, where it was decided to move towards an internal market and the Single European Act, that a firm date could be agreed upon for the membership of Spain and Portugal - the 1st of January 1986. Here, too, enlargement to the south had an impact on the way in which the Community would develop. Individual policy areas, in particular the Common Agricultural Policy were affected the most. Regional policy had to be expanded in order to gain approval from the new members on the internal market - and much more besides. When we look at the factors influencing enlargement to the south in our graphic, it is clear that all the determinants played a role in the process this time.

Because the Treaty required that all member states had to reach a unanimous decision, agreement was made very difficult because of the differing attitudes and interests involved. Tension between enlargement and deepening. The first was only possible with a simultaneous move towards deeper cooperation (SEA and internal market). Sectorial interests, particularly in agriculture. National interests with regards to the EU's further development. Should the future direction of the EU take on a more intergovernmental character, concentrating mainly on economic benefits - in line with with what Britain and Denmark wanted - or should it make

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further steps towards deepening cooperation including the integration of the political dimension in line with what countries such as Germany wanted. And finally fears about the EU system becoming incapable of making decisions set against the background of large growth in the Community's heterogeneity with the enlargement of the EU to the south. All in all, it can be said that the most unproblematic expansion of all was the last in which Austria, Sweden and Finland joined. The relationship between the countries belonging to the EFTA and the Community had been governed since 1972 in the form of bilateral free trade agreements, which were replaced in January 1994 by an agreement on the European Economic Area (EEA). This means, then, that trade relationships had been very close for a long time; many of the EU's regulations, especially those connected to the internal market, had been adopted by these three countries as part of the EEA agreement before their membership. Moreover, all three countries boasted a relatively high level of economic development. One of the most important potential political problems had been their neutral status, but this problem had faded greatly since the fall of the Berlin wall and the end of the Cold War. Indeed, given the interest of these countries in issues such as transparency and social and environmental policy, many expected new impetus for existing EU policies.

III. Enlargement to the East The 2004 enlargement process was trigged by the collapse of communism in Central and Eastern Europe, by the process of transformation and the severe economic and social problems that followed this collapse and by an understandable desire on the part of these countries to receive help and support from the West. The first response of the EU to this new situation was to enter into a bilateral Association Agreement with a large number of CEEC countries. The core objective of the Europe Agreement was to establish a large European market encompassing all associated states. A great deal was expected of these countries: They were expected to adopt the rules of the internal market and to restructure fundamentally their domestic economies. To do this, the EU granted these countries financial aid within the scope of a number of programs.

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Having started out as a policy of association, financial aid and identifying common areas of interest, this position changed fundamentally following a decision taken by the European Council of Copenhagen in June 1993. Here the decision was taken to offer all associated CEECs the possibility of EU membership, provided they could fulfil certain conditions, or rather, the accession criteria. These criteria included: a stable institutional structure based on democracy, guaranteeing human rights and minority rights; a working market economy and the CEEC countries were also expected to a make themselves ready to adopt EU law in its entirety and to adopt the aims of political union and economic and monetary union. Once the Central and East European countries had made an official application to join the EU between 1994 and 1996 (Cyprus and Malta made their applications in 1990), the European Council requested the Commission to prepare a report in accordance with Treaty requirements. The objective of this report was to scrutinize the situation in each of the potential candidate countries and to determine the degree to which they met the membership criterion and whether or not they were in a position to take on the responsibilities and obligations of membership The Commission published these reports in July 1997 in a document called Agenda 2000. Based on the membership critereon laid down by the Copenhagen European Council, the Agenda 2000 comes to the conclusion that Hungary, Poland, Estonia, the Czech Republic and Slovakia might be in a position to meet the conditions set out and, initially at least, recommends beginning accession negotiations with these countries plus Cyprus. Nevertheless, this report also makes it clear that just because negotiations will begin at the same time does not necessarily mean that they will reach a conclusion at the same time. According to the report, the speed at which a conclusion is reached should depend on the progress made in each individual country. In addition to a large number of recommendations from the Commission in its Agenda 2000 document aimed at involving the applicant countries in enlargement process, the European Council decided at the end of 1997 in Brussels to adopt a proposal to convene bilateral intergovernmental conferences to begin negotiations with those countries that were well on 88

the way to fulfilling the necessary requirements. These countries were Cyprus, Hungary, Poland, Estonia, the Czech Republic and Slovenia. Negotiations with this "first wave" of applicant countries - the so-called "Luxemburg Group" - began in the spring of 1998. In December 1999, Heads of State and Government meeting in Helsinki decided to enter into membership negotiations with the "second wave" nations, also known as the "Helsinki Group", (Bulgaria, Latvia, Lithuania, Malta, Rumania and Slovakia). Accession negotiations officially began with these countries on the 15th of February 2000 in Brussels. In November 2000 the Commission published a strategy paper on enlargement containing a "road map" designed to ensure that the EU would be in a position to receive new members starting at the end of 2002. The European Council of Nice approved this strategy paper. The European Council of Nice was also responsible for the Treaty of Nice (ratified on 26.02.01), which was drawn up to ready the EU for enlargement and which involved institutional modifications among others. The European Council of Laeken in December 2001 concluded by declaring that the enlargement process was irreversible and emphasised the determination of the EU to conclude the current membership negotiations by the end of 2002 In terms of our determining factors, another interesting fact is that this Summit meeting also reached agreement on setting up a convention on the future of the EU, which was charged with preparing an intergovernmental conference in 2003/2004 to address the issue of a European Constitution. Another very interesting point here is the fact that the membership candidates were also invited to take part in the convention, without being given the opportunity to block solutions that had been reached amicably between the existing member states. The next important stage along the road to enlargement was the European Council of Copenhagen in December 2002. The accession negotiations with the ten candidate nations were completed, the 1st of May 2004 was set for their membership and the financial agreement for 2004 - 2006 was finally agreed upon. This represented the first really difficult moment in the new 25-member-state Union. In addition to this, the European Council also set 2007 as the date for the membership of Bulgaria and Rumania and decided that the decision as to possible negotiations with Turkey should be dropped based on a report by the Commission in December 2004. Moreover, the conclusions of the Presidency stated that the

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new member states should be completely involved in the intergovernmental conference concerned with preparing and adopting a European Constitution. After the European Parliament, whose approval is absolutely necessary, agreed, the heads of state and government and foreign ministers of the member states and the ten membership candidates signed the accession contract on the 16th of April 2003 at a ceremony in Athens. The accession contract also contained rules on how the 10 new member states would take part in the EU institutions from the signing of the contract until the official membership date of the 1st of May 2004. During this period the new member states held official observer status in all of the Council's committees and included the right to expression. But they were not entitled to take part in voting. The next decisive hurdle for the continuation of the accession process was the referendums to be held in nine of the membership candidate countries (with the exception of Cyprus, which had decided not to hold a referendum) which would decide on the membership contract that had been negotiated and on whether or not each country would join the EU. The following illustration gives the results of these referendums. It should also be pointed out that these referendums demonstrate clearly that the enlargement process was by no means a phenomenon that was restricted to the government level! On the contrary, the national parliaments and, indeed, the citizens of the countries holding a referendum were very much involved, meaning that the governments were forced into making sure that a majority of their population were in favour of the expansionary course. This also applied, of course, to the existing member states. This means, then, that the enlargement process involved and linked a number of different levels together. Indeed, this is a very decisive point and one that makes analysis so difficult! Specific features of the enlargement to the East As far as the special characteristics of enlargement to the east is concerned, the first major factor is the number of applicant countries, which is four times higher than any single previous expansion of the Union. The large number of applicant countries created enormous problems while trying to balance out inter-Community interests. Membership of so many new countries has increased the EU's already pronounced heterogeneity on a massive scale.

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The CEEC countries that joined the EU a few months ago are undergoing a far-reaching process of transformation. This process includes state institutions, administrations and economies, whose future role in a free-enterprise system still partially remains to be defined and which demonstrates a very fragile and unfinished character. Yet state institutions, administrations and economies have to work reliably for the implementation and control of the EU's regulations. These clear administrative weaknesses even in the applicant countries that have made most progress means that grave difficulties look certain to arise during the implementation of the EU's structural policy, as one example. Moreover, there is also the issue of the low level of economic development in the new member states, which, at only 32 percent of the EU's average GDP per capita, means they will be in need of long-term support. More than in any of the previous expansions, the EU will become a development Community. If we take a look at some of the concrete problems that will face the EU as a result we can see that these are most pronounced in agricultural and structural policies, which can be highlighted with only a few numbers. Turing once again to the huge discrepancies in the level of wealth among current and potential member states. Big differences already exist within the EU. Denmark's gross domestic product (GDP) per capita, for example, is 25% higher than the EU average (125%), whereas Portugal and Greece only manage half the average (50%). GDP per capita in Poland and Hungary, which have made most progress among the applicant countries, is only half of the GDP in these, the poorest EU member states! Should these two areas of agriculture and structural policy be dealt with in the same way as for Portugal and Greece, this would trigger additional annual costs of around one third of the current EU budget (100 billion euros in 2004)! The lion's share of this transfer would go into agricultural policy. One of the reasons for this is the number of people working in this sector. In Poland, for instance, and while also bearing in mind that it is one of the countries that has made the most progress, around a fifth of its population work in agriculture - the EU average is only 5 percent. These examples have provided a sufficiently clear picture of the scale of the difficulties connected with the enlargement program and it is obvious that sweeping internal reforms are needed to the EU.

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Romania Member State of the European Union from 1 January 2007 On 26 September, the European Commission issued its last Monitoring Report which reconfirms 1 January 2007 as the date of Romanias accession to the EU. Thus, the Commission points out that, in the light of the progress made, Romania will be in the position to assume, starting with 1 January 2007, the rights and obligations deriving from EU membership. The Report of the Commission acknowledges that Romania has made significant progress in all the areas of concern highlighted in the Report of 16 May 2006 (reform of the judicial system, the fight against corruption, taxation, and agriculture), as well as regarding all three accession criteria. Romania fulfils the political criteria and is on track with regard to the economic criteria and the acquis. Also, the Report provides details on the accompanying measures stated in the Accession Treaty or the community acquis, that could be adopted, if necessary, in cases of non-compliance with the commitments. Currently, ensuring a quality integration in the European Union remains Romanias priority objective. In order to meet this objective, Romania is committed to:

Continue the pace of the internal preparation, in order to ensure the real integration and functioning into the Union after accession. Finalize the process of ratification of the Accession Treaty before the end of 2006 so that accession becomes possible on the 1 January 2007. Prepare for EU membership by putting to good use the experience gained as an active observer to the works of the European institutions.

Accession Process In December 2004, Romania closed the accession negotiations to the European Union. The European Council of 16-17 December 2004 reconfirmed 1 January 2007 as the date of Romanias accession to the EU. Chronology of Romania-EU relations On 25 April 2005, Romania and Bulgaria, together with the representatives of the 25 member states of the Union, signed in Luxemburg the Treaty of Accession to the European Union. The signing of the Accession Treaty came after the assent of the European Parliament on 13 April 2005, given by an absolute majority of votes.

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Until now, the Treaty was ratified by 22 Member States, namely: Slovakia (21 June 2005), Hungary (26 September 2005), Slovenia (29 September 2005), Cyprus (27 October 2005), Greece (2 November 2005), Estonia (16 November 2005), Czech Republic (6 December 2005), Spain (14 December 2005), Italy (22 December 2005), Malta (24 January 2006), Latvia (26 January 2006), United Kingdom (16 February 2006), Portugal (8 March 2006), Lithuania (30 March 2006), Poland (30 March 2006), Sweden (9 May 2006), Austria (11 May 2006), the Netherlands (13 June 2006), Finland (19 June 2006), Ireland (21 June 2006), Luxemburg (29 June 2006) and France (3 October 2006). Romanias progress in the accession preparations were monitored by the Commission by means of the same instruments used for the 10 states that acceded to the EU in 2004 monitoring reports, early warning letter, peer-review missions, and consultations on specific issues. The first Monitoring Report was issued by the Commission on 25 October 2005 and was followed, on 7 November 2005, by an early warning letter that highlighted, in the light of the findings of the Report, the priority areas where Romania had to continue the preparations for accession. The second Monitoring Report was presented on 16 May 2006 and stated that Romania will be ready for accession on 1 January 2007 provided that a number of outstanding issues are addressed. The last Monitoring Report of the Commission was published on 26 September 2006 and re-confirmed 1 January 2007 as the accession date of Romania to the EU.

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