Economic integration within the EU has come a long way. The vision of people, goods, services and capital moving around freely within the Single Market has been made reality in many domains. This has been good for Europe. Individuals can live, work, study or retire in any EU country. Consumers have a wider choice of products and services at lower prices. Businesses have lower costs and more opportunities to thrive in a Europe of close to 500 million customers without internal borders. Businesses have also lost market power and have been pushed to raise productivity levels1, thus contributing to job creation and growth.
The estimated gains for the EU economy include an extra 2.2% on GDP and 2.75 million more jobs between 1992 and 2006.2 However, the initial high hopes – that the Single Market would serve as a catalyst for creating a more dynamic and innovative economy – have not been met.
The Single Market still has significant untapped potential and needs to adapt to a new environment. Over recent years, the pace of European market integration appears to have slowed down. Despite the improvement in the competitive environment, rules and regulations continue to limit the movement of economic resources to more productive activities. Tackling these shortcomings is increasingly important given that the EU needs to respond adequately to the opportunities and challenges posed by the continuously evolving economic environment driven by the progressive EU enlargements, demographic developments and globalisation.
A key change in the Single Market environment since its inception was the introduction of the euro in 1999. While the euro complements the Single Market by reducing costs and increasing transparency, and thus increasing integration and competition, the converse is also true – the Single Market complements the euro, and in particular its ability to adjust smoothly to shocks. The ability of prices and wages to respond quickly, and that of people and capital to move easily within the Single Market, is essential because this allows rapid and market-based adjustments to economic shocks – thus avoiding boom-to-bust cycles in the economy. Moreover, a well-functioning Single Market helps the European Central Bank to maintain price stability.
A further development in the Single Market is the increasing importance of service sectors and network industries. Services now account for around 70% of employment and value added in the EU, but for only 20% of trade between EU Member States. While the rapid diffusion of Information and communication technology (ICT) is opening up new potential for further economic integration in these sectors, it can be lost if significant regulatory barriers to cross-border trade in services remain in place. The removal of such barriers often requires overcoming opposition from special interest groups or even a general public that is unconvinced about the benefits of reform. This underlines the importance of a more evidence-based policy agenda.
European companies are also facing the challenge of globalisation. They are squeezed between the continued dominance of US enterprises in knowledge-intensive industries and the move up the value chain of their Asian competitors. Evidence suggests that the Single Market has been insufficient as a driver of innovation. Innovative companies fail to take full advantage of the opportunities given by the Single Market – while around 60% of innovative companies launch new products on national markets, only 25% do so across national borders.
Such weaknesses in the functioning of the Single Market cannot simply be resolved by changes in the legal framework. A better knowledge of how markets operate and where the bottlenecks are is essential. Knowing this, we can then define better policies to make markets more efficient and European industry more competitive.
A new market-monitoring tool
In order to better address these weaknesses, the European Commission proposed in early 2007 to change the governance of the Single Market, making policies more impact-driven. One of the main elements of these proposals is the introduction of a systematic and integrated approach to market monitoring. By investigating the nature of market malfunctioning in the sectors that are the most important for growth, jobs and adjustment in the EU, it would contribute to putting in place more effective policy instruments.
Building on existing expertise within the Commission and the EU Member States, we have developed a two-stage approach to market and sector monitoring.3
The first, screening stage is necessary because it helps focus our effort on sectors and markets that are important for growth and adjustment, in which there is scope for policy intervention. Three selection criteria are used. The first is the economic importance of the sector. The second, novel criterion is its significance for the adjustment capacity of the EU economy. The objective is to identify the sectors that play a pivotal role in fostering smooth adjustment to changing economic conditions. This is done on the basis of data that have only recently become available. An EU-wide input-output table is used to compute the backward and forward linkages of different sectors. The underlying argument is that problems in market functioning in the sectors with important inter-linkages with other parts of the economy can have important repercussions throughout the economy, slowing down adjustment. The contribution of a sector to the development, absorption and diffusion of innovative technologies is gauged by the extent to which it either produces or uses ICT. The third criterion is price stickiness as measured by the frequency of price changes. Sectors with sticky prices can be seen as bottlenecks slowing down the transmission of price changes throughout the economy.
For the second stage, an in-depth investigation of selected sectors is envisaged, which is aimed at identifying the causes of market malfunctioning within these sectors, and at determining whether further action is warranted.
A first sector screening has been carried out, resulting in a short list of sectors that could be considered for further investigation.4 The majority of the sectors on the list are service sectors that use ICT intensively – distribution activities, financial services, post and telecommunications, and professional services. The manufacturing sectors are electrical machinery, radio TV and communication equipment, and machinery. These nine sectors account for 26% of EU value added and 28% of employment. They also are responsible for a major share of the EU-US productivity gap. The sectors included in this list are hardly surprising, but at least their selection is based on a sound analysis.
A preliminary analysis of the main causes for market malfunctioning has been made for the selected sectors. While the lack of (incentives for) innovation and inadequate market regulation appear as a cause of market malfunctioning in almost all of the sectors identified, services are more affected by lack of integration and insufficient competition. In particular, there are indications of weak competition in electricity and gas, retail trade, postal services, financial services and professional services.
Basis for a new approach to the Single Market?
To advance the Single Market, the European Commission has recently tabled proposals aimed at tackling the deficiencies identified.5 It focuses on improving the governance of the Single Market by basing proposals for policy intervention on economic analysis of market functioning.
One innovation is that the choice of policy measures is not made ex-ante, but rather ex-post following a period of market monitoring and analysis. The nine underperforming sectors identified in the screening stage are under consideration for such market monitoring. By better understanding how these markets function, we can define more effective policies, combining horizontal and targeted measures.
Another innovation is that we aim at analysing the potential interactions between different instruments to arrive at a consistent and comprehensive strategy. As problems affecting market functioning often have multiple origins, they can only be tackled by using more than one policy instrument. In the same vein, the interactions between policies being implemented at the local, regional, national and Community level need to be taken into account. Under a well-developed policy strategy, action taken at different levels is targeted at achieving common objectives. This would require cooperation already at an early stage. The involvement of the national authorities in the market monitoring exercise now underway is therefore of the essence.
1 Bottasso, A. and A. Sembenelli (2001), "Market power, productivity and the EU Single Market Program: Evidence from a panel of Italian firms", European Economic Review, vol. 45, pp. 167-186
2 Dierx, A., F. Ilzkovitz, V. Kovacs, N. Sousa, "Steps towards a deeper economic integration: The Internal Market in the 21st century", European Economy Economic Papers nr. 271, January 2007
3 "Guiding principles for product market and sector monitoring", European Economy Occasional Papers nr. 34, June 2007
4 "Implementing the new methodology for product market and sector monitoring: Results of a first sector screening", Commission Staff Working Document SEC(2007) 1517
5 "A single market for 21st century Europe", Communication from the Commission COM(2007) 724