Diego Zuluaga // 03.08.2016

The Wednesday Briefing is a weekly free-market commentary on topical economic issues by our Head of Research, Diego Zuluaga.

The European Union is all things to all people. To proponents on the right, it is a force for international cooperation, trade promotion and economic growth. To those on the left, it serves to enhance labour and environmental standards, to hold corporations to account, and to tackle problems which reach beyond national boundaries. Meanwhile, right-wing Eurosceptics see the EU as mostly a bureaucratic machine, promoting not freer markets, but corporatism and regimentation; whereas to left-wing sceptics it is a neoliberal conspiracy to undermine democracy and enforce the will of the rich and powerful.

There is at least some truth in all of these characterisations. The EU has served to expand cross-border trade among its Member States and, crucially, to integrate the nations of the former socialist camp into global markets. It has also, since the Commission presidency of Jacques Delors, taken up labour-market regulation, whilst also spearheading the Emissions Trading System, the world’s first regional cap-and-trade scheme.

On the other hand, the EU has increasingly centralised legislative power in areas such as financial regulation and product standards, leading to one-size-fits-all rules which in many cases place onerous burdens on businesses and consumers. This centralisation has facilitated the capture of the legislative process by both business interests and pressure groups – the latter often funded by the EU itself. Increasingly, there is a perception that the Union is governed through backroom deals among national governments, interest groups and unelected officials, with little oversight from the electorate or other institutions. This has most recently become apparent in the TTIP debate.

A force for liberalisation?

For those who believe that free and open markets are an essential ingredient for the flourishing of individuals and societies, a central question when it comes to the EU is whether it actually serves to promote economic freedom in its Member States. In a briefing paper for EPICENTER published today, Alexander Fritz-Englund looks at the evidence from the past 50 years.

Fritz-Englund finds that the EU has historically tended to promote freer markets, sound money and open trade in its member countries. His results hold when controlling for country- and year-specific factors, and they are not limited to the A8 post-communist countries that joined the EU after 2004 and newer Member States. On the contrary, a similar trend towards greater economic freedom is observable for the EU15 group of older members.

Figure 1. Average economic freedom for the 15 countries which joined the EU prior to 2004 (red line) and the 13 countries which joined in 2004 and after (blue line). Source: Fraser Institute, 2015.

Fritz-Englund’s results are statistically significant across most categories within the Fraser Institute’s respected Index of Economic Freedom, including ‘freedom to trade,’ ‘regulation,’ and ‘size of government.’ The strongest relationship is observed in the category of ‘sound money,’ which should not come as a surprise given that the introduction of the euro has brought monetary stability to countries – such as Italy, Spain and Greece – which before the single currency were accustomed to high rates of inflation. Furthermore, Bulgaria and Denmark – and the Baltic states before their euro entry – have a euro peg, which helps to anchor sound money whilst maintaining national currencies.

As with any correlation, it is difficult to determine how much of the relationship is cause-and-effect. It is no coincidence that economic freedom in Europe bottomed out in the mid-1970s, the high water mark of postwar dirigisme and stagflation. Market-oriented domestic reform and trade liberalisation since then have surely contributed to the recovery of economic freedom that is apparent in the data.

At the same time, the spike in the indicator immediately before and following entry into the EU suggests that third factors tend to play a smaller role than EU membership for the average Member State. It is not unreasonable to assume that the EU is the dominant factor, given that it sets a number of important economic conditions for accession on prospective members. These include the free interplay of market forces in labour and product markets; macroeconomic stability; a system of enforceable property rights and contracts; and limited state influence on the competitive process.

Figure 2. Estimated effect of membership of the EU on the economic freedom of Member States, 1973-2007. Source: Alexander Fritz-Englund.

Indeed, for countries in southern Europe in the 1970s and 1980s, and east-central Europe in the 1990s and 2000s, the aim of EU membership was one of the great spurs for economic reform. It is not far-fetched to argue that the prospect of belonging to what was then a select club of rich Western states made the pill of economic restructuring easier to swallow. Moreover, the EU’s constitutional provisions against state aid and its limits on national debts and deficits – albeit much disregarded – have for the most part helped to entrench sound economic policy in these countries following accession.

Similarly, we can see in Figure 1 that liberalisation in the EU15 gathered pace with the signing of the Single European Act in 1986. But it is also apparent that liberalisation tailed off in the older Member States around 2000, whilst economic freedom has in fact declined in these countries since the onset of the financial crisis. Part of this reflects the accession of less free Member States in the 2000s, which brought down the Union average. Yet, even eastern European members, long viewed as enthusiastic adopters of free markets, have seen progress stall since 2008.

Could the EU also be a drag on economic freedom?

The evidence, in addition to suggesting that EU membership tends to promote economic freedom, raises two important questions. First, does the EU also place a ceiling on the level of liberalisation that countries can achieve whilst remaining members? Second, is the lack of progress on economic freedom in the past decade a cyclical pause which will end when economic growth picks up, or a structural phenomenon related to long-term changes in the direction of economic policy?

It is not difficult to imagine how EU membership could put a limit on how economically free its members can become. An increasing amount of business and financial regulation is determined at EU level. If these interventions harm economic freedom, they will do so across all Member States. The EU also controls external trade policy and, in 19 Member States, is also in charge of monetary policy through the European Central Bank. Any deviation from openness and orthodoxy on these fronts will thus harm economic freedom in the entire Union.

Furthermore, the EU has plans – outlined in the 2015 Five Presidents’ Report – to expand its reach in social policy – including minimum wages and workplace rules – as well as to take up a bigger share of public expenditure. To the extent that such harmonisation leads to increased intervention, economic freedom will be harmed across the board.

The second question is related to, but independent from, the first one. Namely, up until the financial crisis there was some degree of consensus in Europe and North America that market reforms were necessary and desirable to ensure continued prosperity. Governments were committed, in principle if not always in practice, to expand the role of markets in the provision of public services, and to reduce the level of intervention in the private side of the economy.

This consensus has largely unwound since 2008. Whilst much is made of the pursuit of ‘austerity’ in recent years, the reality is that such frugality has, more often than not, involved tax raises over spending cuts and structural reforms. The appetite for market liberalisations has diminished, both at national and EU levels. For example, the European Commission used to emphasise pension reforms in the direction of private saving and away from increasingly unsustainable PAYGO schemes. Now its efforts have been diverted towards Keynesian stimulus measures – the Juncker Plan – and new interventions on the fiscal and regulatory front, ostensibly to shore up the euro.

We should care about the EU’s role with regard to the promotion of economic freedom. Economic freedom has consistently been found to be positively correlated with a range of desirable outcomes – such as higher rates of economic growth, higher life expectancy and better standards of living for the poorest – and negatively correlated with undesirable ones – such as poverty, disease and economic stagnation. There are no ready examples of countries around the world which are doing well without allowing a large measure of freedom for individuals and businesses.

The European project is not an end in itself, but rather a vehicle for the achievement of human flourishing – including wealth and peace – across the continent. It is therefore worth cherishing and preserving to the extent that it promotes this objective. And the historical evidence tells us that this in turn necessitates the advancement of economic freedom.

Diego Zuluaga is Head of Research at EPICENTER. This is the last edition of the Wednesday Briefing before the summer break. EPICENTER will return to your inbox in September.