The euro crisis is threatening the EU Single Market

Last week, on time to coincide with the 20^th anniversary of the EU Single Market, the European Commission presented its proposals for the further liberalizations. The proposals include the strengthening of cross-border competition and consumer choice in areas such as air travel and electricity.

And yet, as laudable as these detailed proposals may be, the EU Single Market currently faces far bigger problems than the deregulation of certain service industries. The euro crisis is threatening to destroy many of the most important achievements of the Single Market. Or, to put it differently: no matter how the euro crisis is handled from here on, the Single Market will never again be what it was in the carefree years of the early 2000s. The Single Market will either shrink in terms of its geographical scope, will be reduced in its depth or even break up entirely.

The Single Market is more than the sum of legal directives and rules allowing obstacle-free cross-border economic activity. Its true potential is harnessed by companies all over the EU that have built up cross-border networks of production. Networks such as these benefit everyone: highly developed countries such as Germany, who are able to outsource certain phases of production to countries with lower wage levels; less developed countries benefit as they experience a rise in income and a transfer of technology; and last but not least the consumers, who are able to choose from a wider variety of products at lower prices.

Each of the imaginable scenarios for the future of the Eurozone threatens to damage these achievements. This is most obvious in the case of the nightmare scenario of a Eurozone break-up: in that case, extreme exchange rate volatility between European countries would once again become commonplace. This would not only dramatically increase hedging costs for cross-border trade but also promote protectionism. It is difficult to imagine, for instance, that the French government would sit by and watch if the devaluation of a new lira meant that the production of Fiats in Italy were to become 50% cheaper compared to French car manufacturing overnight. Under the current circumstances (a protracted recession, rising unemployment and social unrest) even the European Commission and the European Court of Justice wouldn’t be able to halt the renewal of protectionism. Entrepreneurs, in turn, would then be more likely to concentrate on their domestic markets when it comes to production and distribution.     

Even in the best possible scenario, the solution of the crisis through a quantum leap in integration – including a banking union and Eurozone-budget – the EU’s Single Market would suffer. On the one hand a push towards deeper integration would strengthen the Single Market in Eurozone countries; but it would also mean a reduction of its geographical scope on the other. A banking union only makes sense if, as suggested by the Commission, common rules are centrally set, as is the case under the current plans of the European Central Bank. In order to avoid this single banking and financial market stretching to the border of the Eurozone but no further, non-Eurozone states would have to agree to adhere to these centrally set rules. This is exactly what the Commission expects: that, in the end, all EU countries will play by rules set by the ECB. Especially Britain, however, is hardly likely to accept the regulation of the City of London by the ECB in Frankfurt. The only possible solutions would be for Britain to leave the EU or for all EU member states to accept a clear division of the market in financial services.

And what will happen if neither a catastrophic break-up nor the United States of Europe come to pass, but heads of state and government continue in the mode of crisis-management they have so far employed (i.e. muddling through and hoping it won’t all come crashing down)? Even if this strategy works, the Single Market will have sustained some damage: in the past months banks in the Eurozone have withdrawn from cross-border business. German banks are giving hardly any loans to Spanish banks and businesses these days. As a result a well-managed Spanish company with a top rating is currently obliged to pay several percentage points more interest on credit than a comparable German company. Indeed, even poorly-managed German companies are paying significantly less interest than well-managed Spanish companies. This is neither fair nor efficient. It isn’t fair, because no company should be discriminated against on the basis of its home country. It isn’t efficient, because it negates the central premise of the Single Market: that the best companies should be able to succeed. It is likely that the governments of those states most affected by the crisis will eventually try to either protect or subsidize their countries’ companies. All of these developments create new barriers and will lead to a renewed focus on domestic markets. For Europe, this means: less competition, less growth and higher prices for consumers.

Whichever way you look at it: the European Single Market has never faced bigger challenges. Even muddling through the euro crisis comes at an enormous price beyond the bail-out billions. The Single Market cannot be separated from the euro crisis. More honesty in this respect may even help to convince the people of the necessity for a swift and comprehensive solution to the euro crisis – even if this means putting a further few billion on the table.

Sebastian Dullien is a Senior Policy Fellow at the European Council on Foreign Relations (ECFR and a professor for economics at the HTW in Berlin) This article is based on an ECFR Policy Memo, published today.