Common trade policy of the EU

Seminar paper Topic 1

Group 1:

The EU in the Global Economy LV 2185, WS 2011/12

Benjamin Doplbauer 0851347 Matea Deranja 1150603 Jan Kaiser 0350713

Group 1: Common trade policy of the EU, The EU in the Global Economy, WS 2011/12

Table of Contents
I. Introduction......................................................................................................... 2 II. Eu trade policy................................................................................................... 4 A. Importance of international trade for European Union....................................4 B. Trade policy in historical perspective..............................................................5 C. Policy makers..................................................................................................9 1. European Commission .................................................................................9 2. Council....................................................................................................... 10 3. European Parliament .................................................................................11 D. World Trade Organisations cooperation with the Euuropean Union.............12 E. Regional trade agreements vis--vis broad liberalization and its benefits....13 F. An overview of eu's trading negotiations......................................................17 III. Foreign Direct Investment...............................................................................22 A. Introduction to the concept of FDI.................................................................22 1. What is FDI?...............................................................................................23 2. Why does FDI take place?..........................................................................23 3. Advantages of FDI......................................................................................24 4. Theoretical explanations of FDI..................................................................25 B. Overview on FDI activities of the European Union........................................27 1. EU direct investment abroad......................................................................28 2. Direct investment in the EU.......................................................................29 IV. References...................................................................................................... 30

I. INTRODUCTION
As the worlds leading trade power, the EU has a strong interest in creating conditions in which trade can prosper. Its position also gives it responsibilities towards the rest of the world and therefore it plays a leading role in international trade negotiations, working towards fair trade and seeking to harness globalisation. Trade policy of EU which is the main object of consideration in this paper has emerged and changed its objectives over years. The main purpose of this paper is to show the

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development of trade policy, its objectives, measures and its decision making roles and powers. It is also pointed out that the multilateral policies for free trade are in the best interest of European Union. Nevertheless, the role of proliferation of regional trade agreements is presented and its challenges and opportunities. It is argued weather the promotion of free trade through preferential agreements can foster trade liberalization and benefit economic development by integrating developing countries into the world economy or the regionalism, will increase discrimination via preferential agreements and undermine transparency and predictability in international trade relations. So far the EU is second most significant importer and exporter of goods and services in the world, the import and export flows are shown as well as their major characteristics. Different commodities traded between trade partners are object of the EU imports and exports. Therefore the major trading partners and trade relations with them are analysed. Trade relations between EU and developing countries are very important factor when considering multilateral trade system. In this context there is given a critical overlook on how the EU is providing support to developing countries, also the ways of protecting its agricultural sector as well its main arguments for doing so. As one of the main characteristics of the world economy and the globalization was a tremendous rise in foreign direct investments, this paper shows and analyses the EU outward and inward FDI stocks and flows, also the benefits of FDIs on european economy are pointed out.

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II. Eu trade policy

In this first part of the paper the general facts of the European Union trade policy will be introduced. The main facts about the EU's legal structure regarding international trade, cooperation between the WTO and the EU will be covered. Furthermore, the importance of trade liberalization is pointed out and its main advantages for the EU. Next, the complex system of trade preferences of the EU is discussed; regional trade agreements and liberalization will be emphasized and its impacts compared. A. Importance of international trade for European Union

Trade policy of European Union is one of the most important policies European Union stands for as well as the EU represents the largest trading bloc in the world, world largest exporter and the second largest importer of goods, and it is the first trader of commercial services (European Commission 2006). If the trade among the member states was included, EU would be responsible for nearly 40 per cent of world merchandise import and exports. In terms of trade composition, EU trade consists predominantly of trade in manufactured goods, while trade in services is mainly in travel and transportation (Tel, 2009). It should be pointed out that the commodity structure of EU trade varies greatly across trading partners. In particular, manufacture goods dominate EU trade with other developed countries, while primary products figure more prominently in trade patterns with developing countries. When thinking about trade and European Union, it is worth mentioning that the trade has a great significance for the foundation of European Union, in fact of European Economic Community. Two of the original core objectives of the European Economic Community were the development of a common market offering free movement of goods, service, people and capital. Free movement of goods was established in principle through the customs union between its six member states on the most beginning. This was a basic goal of the Union from the earliest days. In the 1960s, the customs union between its member countries has been created (Gunter,

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1999). In other words, any EU country could trade any quantity of goods with any other EU country without having to pay customs duties and tariffs. In addition to internal trade, which is called Free movement of goods and services, even more important for the European Union is its external trade and its Trade policy (Common Commercial Policy) applying to relations with third countries which is the main object of consideration in this seminar paper. The Trade Policy, often called Common Commercial Policy has been one of the most important and dynamic fields of EU external relations. It is one of the three common policies aimed in Treaty of Rome, besides agriculture and transport (Gunter, 1999). Since its inception in 1957, the scope of the Trade Policy has been enhanced in order to adapt to the new realities of international trade and economic relations. During the past 20 years the Common Commercial Policy was the subject of significant amendments and changes in order to adapt to internal and international challenges that EU is facing, such as globalization and the trend towards liberalization of international economic regulation which is very much recommended by WTO. Beyond trade in goods, nowadays EU Trade Policy includes 2 more fields; trade of services and intellectual property.

B.

Trade policy in historical perspective

Since the Treaty of Rome in 1957, EU member countries accepted to speak with one voice in trade, transferring their sovereignty and its own voice in this policy area to the supranational level. In Article 3b of treaty of Rome, the EEC adopted the goal of introducing a Common Commercial Tariff (CCT) and of establishment of Common Commercial Policy towards third countries (Gunter, 1999). One of the provisions in Treaty of Rome is The EEC shall contribute to the harmonious development of world trade and to the gradual removal of both barriers to trade and of tariffs (The Treaty of Rome, 1957). It is also worth mentioning that the cornerstone of

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the CCP is Article 133. according to which the CCP establishes uniform principles between all member states governing EU trade policy including changes in tariff rates, the conclusion of tariff and trade agreements with non-member countries, uniformity in trade liberalisation measures, export policy and instruments to protect trade such as anti-dumping measures and subsidies (Treaty of Rome, 1957). The Common Commercial Policy (Trade Policy) was the only field where external Community action was explicitly recognized in the original EC Treaty (TEC). The drafters of the Treaty of Rome had recognized that the Community should be granted powers in the field of external trade in goods, so as to satisfy the need for external representation of the European Community (EC) as a customs union (Cremona, 2002). In 1968, the Customs Union entered into force among the six EU member countries, remaining duties were eliminated among them, and a Common External Tariff was introduced to replace national tariffs vis--vis nonmember countries. Since then, the scope of the trade policy, as mentioned before, has expanded in two important dimensions: first, the members of the Customs Union have increased to 27 by the moment; secondly, trade policy has broadened to include trade in services and intellectual property (Conconi, 2009). The expansion in these fields took some time. What exactly encouraged the expansion of Trade policy will be introduced later on. Although the tariff barriers were removed, many non-tariff barriers to trade still remained. For example, different EU countries had different administrative requirements and different rules on things like packaging and labelling, all of which disrupted trade between them. Establishment of CCP ended by 1970. After the time gold convertibility was abolished in USA, the world economy faced a lot of problems, as did Europe as well. Even some EEC countries raised back trade barriers between 3rd countries but also within themselves. Things became even worse on the end of seventies due to the oil price shock. What followed was the internal adjustment in eighties and nineties; it means countries had negotiated free trade agreements with

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their partners. The European Council provided leadership in relaunching Europe in 1983/84. Governments have recommitted themselves to the original programme of the Treaty of Rome, and thus convinced business that the cosy times of protection were over. (Gunter, 1999) Import rules ought to be harmonised and restrictions on Intra-Community trade were gradually phased out. Indeed, national measures of protection were discontinued in many areas until 1992, and in areas such as textiles and clothing, agriculture, automobiles, footwear and public procurement, policy makers opened up Euro market considerably, although not always on permanent basis. The establishment of the WTO in 1995 marked a new era and was the main reason for instructing changes in the Common Commercial Policy. The WTO Agreement not only provided new, more rigorous and institutionalized framework for trade in goods, but it also established international rules on trade in services and trade related intellectual property rights. Recognizing the importance of the services sector as the most dynamic economic sector and that supply of services beyond national borders was an important aspect of it, the WTO Agreement took the next step in regulation and liberalization of the world economy. Furthermore, minimum levels of protection of intellectual property rights were considered necessary for ensuring the effectiveness of trade rules. The General Agreement on Trade in Services (GATS)1 and the Agreement on trade-related aspects of intellectual property rights (TRIPS) 2 become next to the GATT part of a single undertaking requiring WTO Members to subscribe to all of them, which had a big impact on CCP. (Conconi, 2009) The scope of the Common Commercial Policy was amended by the Amsterdam Treaty from 1997. However, instead of incorporating trade in services and trade-related aspects of intellectual property in the Common Commercial Policy, a new paragraph was added to Article 133 TEC, which enabled the Council to extend the Common Commercial policy in these fields by unanimous decision after consulting with the Parliament.
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General Agreement on Trade in Services Agreement on Trade Related Aspects of Intellectual Property Rights

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However, such decision was not taken until 2003, when the Treaty of Nice, which amended again Article 133 TEC, came into force (Cremona, 2011). The most important innovation brought by the Treaty of Nice is that it established an express competence to negotiate and conclude international agreements in the fields of trade in services and commercial related aspects of intellectual property. Later on, worth mentioning is the role and impact of The Lisbon Treaty which is important milestone in the evolution of the Common Commercial Policy and it surely introduces a new era in EU external relations. It contributed to the development of a coherent, effective and all-embracing commercial policy, reflecting in the field of external relations the degree of internal economic integration. (Conconi, 2009). The Lisbon Treaty expanded scope of Trade Policy to foreign direct investment, which made EU more competitive in the world. The way of emergence of Trade policy of European Union has not been an easy process. A fair and transparent rules-based system has been built and upgraded over years. Today EU trade policy covers even a broader scope beyond trade liberalization. It is about updating and improving international rules, and giving them a wider coverage to ensure fair trade and harnessed globalization. It is about promoting an international agenda that benefits the developing world, and addressing issues of general public concern. One of the key challenges today is to ensure that trade rules take account of non-market concerns, particularly the environment, public services, food safety, agriculture and culture. It is also important to mention that development of Trade Policy has been influenced with global trade issues which are covered and conducted under WTO. EU has also been participating in negotiating rounds and the last round it has made a lot effort in pursuing the Doha Development Agenda, which is still open issue. It is about ensuring that developing countries can benefit from trade, and using trade as a key element of every countrys drive to achieve poverty reduction and sustainable development, in that field EU is working hard and is very committed in

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helping developing countries to go out of poverty, even the EU has opened its markets totally to least developed countries.

C.

Policy makers

Many institutions and individuals are involved in the decision-making process within the framework of CCP. Preferences of member governments, economic interest of lobbies, and policy ambitions of the Commission may all pull the process in one direction. In this case third countries have to face a tough bargaining partner.

1.

European Commission

In terms of the decision making process, the European Commission has sole competence over the implementation of the CCP, proposing eventual new initiatives to the Council and managing trade tariffs and other trade policy instruments, and conducting trade negotiations (Burkhart & Matthews, 2007). The Commission maintains the right of initiative, for its proposals to be formally adopted, agreement has to be reached between the co-legislators, while the European Parliament decides jointly with the Council on the framework of EU trade policy through the ordinary legislative procedure (European Commission, 2011). When the EU is engaged in trade negotiations with third countries, its members act as a single voice (Conconi, 2009). WTO is one of the only international organizations in which the Union is itself a member and in which EU member countries are represented by the European Commission. Reaching a one voice in trade policy is often a complicated process, since EU members have different trade policy interests and agreeing on a collective policy and bargaining position requires compromises among them (Tel, 2009).

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It is to be pointed out that Council needs to approve what Commission negotiates. The Commission is empowered to suggest negotiation directions and conduct negotiations in consultation with a special committee appointed by the Council for this purpose. For example, the Commission negotiates on behalf of the member states in the WTO. The Commission may sometimes interpret its decisions in a way with which some member states may disagree, and this has been a source of tension in the past. Furthermore, before the inclusion of trade in services and commercial aspects of intellectual property, the powers vested to the Community were exercised by the Council and the Commission but after the Treaty of Lisbon there were few changes regarding the decision making process. These changes refer to decision-making power of Parliament and will be discussed below. 2. Council

Trade policy takes place in the bargaining framework established by the Council and Commission, therefore the role of the Council in decision making process regarding trade is extremely high. It is a center of decision-making. It retains power over setting policy goals and guidelines for negotiations, over secondary legislation on and the implementation of trade remedy laws, and over the conduct of negotiations (Gunter, 1999). At the conclusions of the trade negotiations, the Council approves or rejects the negotiated trade agreement. International agreements are adopted by the Council, after the Parliament has given its consent. Even though the Treaty of Rome allowed QMV (qualified majority decision) in crucial policy issues, unanimity became the norm of conduct and is required regarding trade in services, commercial aspects of intellectual property and foreign direct investment where such agreements include provisions for which unanimity is required for the adoption of internal rules (Kleimann, 2011). Member states are assigned different voting weights, which reflect the size of their populations, and ratification requires approval by two-thirds of the votes.

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The political legitimacy should rest in hands of Council, because guidance has to originate there. Without strong influence the CCP would not be effective at all.

3.

European Parliament

Despite its legal empowerment, Parliament has a priori entered the political arena as the weakest of the three institutional players. It for sure lacks the experience in CCP formulation regarding working relations with its institutional competitors on CCP issues and staff capacity; it is a politically extremely fragmented institution. Parliament had no experience whatsoever in the conduct of trade and investment policy-making. The Commission and Council consult the EP, and this has become more formal with the establishment of the International Trade Committee (INTA) in 2004. There is a growing acceptance among policy makers that trade can no longer operate in a hermetically sealed box, but must be more open to scrutiny and debate (Woolcock, 2005). The most important change brought by the Lisbon Treaty with regard to decision making in the field of the Common Commercial Policy affects the institutional balance and now it provides a more active role for the European Parliament. Following the trend of granting a wider role to the EP and enhancing the legitimacy of external relations, Article 207 alongside Article 218 TFEU render the European Parliament a co-legislator in the field of the Common Commercial Policy (European Parliament, 2011). The European Parliament has the right to make amendments and also has a final veto power with regard to internal measures (Krajewski, 2010). Nevertheless, it has also gained a special right to be informed with regards to negotiations of international agreements. Regarding conclusion of trade agreements, the European Parliament needs to be consulted before the Council concludes an agreement and hence it is not only a co-legislator for the implementation of international agreements, but also needs to give its consent to the conclusion of the agreement.

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D.

World Trade Organisations cooperation with the Euuropean Union

The European Union has always supported the multilateral trading system. It has played a major role in setting up the World Trade Organisation, and it is a very active participant in the WTO. Although every member state has the right to attend WTO meetings, it is only the European Commission that represents the entire EU and acts as a single voice instead of all EU countries. The World Trade Organisation is the core of the international rules-based system for world trade. Based in Geneva, it provides a forum for multilateral negotiations on trade, together with a rule book and mechanisms for ensuring that its members play by the rules. So far WTO is standing for removing obstacles to trade, creating and enforcing global rules and making them compatible with rules drawn up by other multilateral bodies, and thus it facilitates and promotes the world trade. As it was already mentioned above, the EU supports the work of the WTO on multilateral rule-making, trade liberalisation and, sustainable development and trough WTO it procures new markets for European companies, observes the rules and makes sure others also play by the rules (European Commission, 2011). The EU is the largest and most comprehensive entity is the WTO. The EU representative in WTO, European Commission, negotiates trade agreements. When an agreement is negotiated at the WTO, the Commission needs to get the formal authorisation of the Council and European Parliament to sign the agreement on behalf of the EU. The WTO's highest decision-making body is the Ministerial Conference, which meets at least every two years, and on these meetings the EU Trade Commissioner is representing the EU. The General Council of the WTO acts on behalf of the Ministerial Conference. The Commission represents the EU in the General Council as well as in the other formations of the General Council which meet on a regular basis such as the Dispute Settlement Body or the Trade Policy Review Body. The Commission also represents

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the EU in subsidiary WTO bodies such as the Council for Trade in Goods or the Committee for Trade and the Environment. The dispute settlement mechanism is also worth mentioning because of its importance for the establishment of WTO and because it guaranties that agreements negotiated will be respected. Since the establishment of the WTO, the EU has been involved in many disputes, being on the offensive more than on the defensive: between 1995 and 2008, it has acted as a complainant in 77 cases and as a respondent in 59 cases. Some of these cases have been widely publicized, such as the long-running disputes between the EU and the Unites States over the EU tariff system for banana imports or over the US subsidies to Foreign Sales Corporations. At this point it is to be emphasized that EU and WTO have been working long time on world trade issues, and were conducting negoriation rounds, one of them is DDA, Doha development round which is still open question. In this paper we wont go in detail within this topic due to its presence in other member papers.

E.

Regional trade agreements vis--vis broad liberalization and its benefits

The conclusion of regional trade agreements may be driven by the search to access to larger merkets, more if there is absence of willingness among WTO members to liberalise further on a multilateral basis. RTA formation could be also driven by economic, political even by security reasons, traditional welfare gains from preferential tariff reductions and because of the market power benefits of forming a larger unit for tariff setting and bargaining. Even though EU operates according to trade rules that are set multilaterally, actually the exchange of goods and services takes place between the EU and its individual trading partners. However, what takes place bilaterally and what happens at the multilateral level often reinforce each other. The EUs bilateral agreements with individual trading partners,

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or with regional groupings of countries, are often designed to pursue goals that are subsequently achieved through multilateral negotiations. There one can see many types of trade agreements: free, bilateral, regional, plurilateral, those of preferential reciprocal nature, those notifies to WTO and those which have not been notified yet. Regional Trade Agreements are significant feature of the multilateral trading system and have become an important trade policy tool for European Union as whole. The number of RTAs as well as the world share of trade covered under them has been steadily increasing over the last ten years and this trend will be further strengthened by the many RTAs being proposed and those currently under negotiation. From the next figure one can see the EU map of regional agreements negotiated so far.

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FIGURE 1: WORLD MAP OF PREFERENTIAL TRADE AGREEMENTS WITH EU

Data source: European Commission, 2011. From the above figure one can see which countries have so far concluded preferential trade agreements with EU, which countries are currently committed in the negotiating process with EU and those with which the EU is considering opening preferential agreements. Therefore it is obvious that EU has developed a really huge network of trade agreements. Initially, these were mainly with neighbouring countries and former colonies, but they now extend to trans-continental agreements without these geographical or historical rationales such as those with Latin American countries. One can ask whether such agreements represent a threat to the multilateral trading system, therefore the answer lies in fact that WTO allows the formation of regional trade agreements (RTAs) as long as trade barriers on average do not rise after integration, tariffs and national trade barriers are eliminated within the area on substantially all intra-regional trade, and the project is notified to the WTO in time for it to determine whether these conditions are satisfied. (Brlhart & Matthews, 2007). As world trade becomes more liberalised, the preferential value of RTAs could diminish. In the long term, it is very likely that all WTO members will enjoy relative freedom of access to Europes market. EU products might, however, suffer from discrimination created by other RTAs. To avert this danger the EU is seeking conformity across the board to WTO rules. As a result, its own RTAs are becoming less discriminatory, more insistent on reciprocity from the partner country and more broadly focused than in the past. They address regulatory issues, right of establishment, foreign investment, competition policy, financial aid and technical cooperation as well as standard tariffs and import barriers per se. (Brlhart & Matthews, 2007). The proliferation of RTAs in EU presents challenges and opportunities; one can ask what is better for the growth of a country: weather to conduct preferential agreements or open its market to international trade.

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According to Vamvakidis and statistics in his paper which was issued by IMF, it says that most of the countries grew faster after opening their markets to international trade. Broad liberalisation has a significant effect on growth even after controlling for participation in RTA. RTAs do not appear to have an affective impact on growth. In contrast, countries have grown faster after non-discriminatory liberalization. Also it is important to empfasize that openness has a positive indirect impact on growth trough investment (Vamvakidis 1998.) In contrast, RTAs are found to have negative impact, even tought not always statisticaly significant, on both growth and investment. Preferential trade agreements it means regionalism practices regarding trade could have some bad effects on multilateral liberalization and on economy , they can promote trade diversion rather than trade creation, thus reinforcing vested interests and increasing opposition to multilateral trade liberalization, e.g. if there is trade diversion, a firm located in a member country, although inefficient, may be able to overcome competition from a more efficient firm located in a non-member state, because it benefits from preferential tariff rates. Large countries may benefit from signing preferential agreements with small countries, in which they can use their market power to extract concessions on nontariff issues, such as labor market or environmental standards, migration or intellectual property protection. (Limao, 2007).This implies that large countries may have an incentive to slow down multilateral liberalization, in order to maintain their bargaining power vis a vis their partners However, EU regionalism may instead be compatible with multilateral trade liberalization. Regionalism and liberalisation do not need to be in conflict, many EU countries are example of this fact. In particular, there are at least three reasons to believe that the EU system of preferences promotes trade rather than hinders, firstly, as mentioned above, although very few countries conduct their trade with the EU on a purely MFN basis, approximately three quarters of imports by the EU enter on nonpreferential terms; secondly, the expansion of the EU web of PTAs from agreements with neighboring countries and former colonies to

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transcontinental agreements that are not driven by geographical or historical links implies that trade diverting effects are less likely to occur; also, the progressive reduction in MFN tariffs has eroded the preferences of beneficiary countries, reducing the risk of trade diversion (Conconi, 2009). It needs to be emphasized that an open market is hard to develop, even it brings for sure faster growth with itself, and therefore it is an elusive goal. Despite much liberalisation, the EU continues to maintain strong defences against sensitive imports such as agricultural products. Regionalism is still a strong focus of EU trade policy. This framework of regionalism, with its discriminatory stance against third countries, might be at the expense of the stability of the multilateral trading system. But still there are notable advantages of regionalism. Encouraging regional integration enlarges markets, reinforces healthy competition between neighbouring countries of comparable levels of development and competitiveness, favouring industrialisation, development and regional stability. It is less an alternative to multilateral liberalisation, and should rather be seen as complementary. Europe needs to decide which way to choose but so far EU is balancing good in both, regionalism and liberalisation.

F.

An overview of eu's trading negotiations

As already mentioned the EU has negotiated a number of trade agreements with other countries. It has recently shifted to a trade policy which is a greater user of Free Trade Agreements (FTAs). In particular the EU is working on a number of new FTA initiatives. Policy statements also reiterate the EUs commitment to multilateralism in trade and to the completion of the Doha Development Agenda. The EU is committed to ensuring that its agreements are compatible with WTO obligations. The EU expects the same of other WTO members and hopes the current international negotiations under the WTO will be a useful opportunity to clarify rules in this field for the benefit of all

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members. The next table presents the list of agreements the EU has negotiated on preferential basis.

The EUs network of preferential trade agreements 2007

Type of trade Name of agreement Countries involved agreement Single market EEA Iceland, Norway Customs Union Turkey, Andorra, Sam Marino, Free Trade Area Switzerland, South Africa, Israel, Mexico, Liechtenstein,

Chile, Faroe Islands Euro-Med Agreements Association Algeria, Egypt, Isreal, Jordan, Morroco, Palestinian Syria, Tunisia Partnership and Cooperation Agreements treatment) Non-reciprocal contractual preferences First Agreements Lom/Cotonou Non-reciprocal autonomous preferences Stabilisation (SAA) and Other developing plus generation African, Caribbean, (MFN Russia, Moldova Ukraina, Authority, Lebanon,

Mediterranean

Pacific countries

Association Agreement countries

members of CIS and

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Western countries Purely treatment MFN Australian, Japan, Taiwan, New Hong

Balkan

Canada, Zealand, Kong, United

Singapore,

States, South Korea Free Agreement enhance cooperation Table 2: The EUs network of preferential trade agreements. Data Source: (Brlhart & Matthews, 2007). As it is notable fom the table above EU has negotiated trade agreements among the whole world. The United States is by far the EUs biggest trading partner, accounting for nearly 22 % of the EUs total trade (exports plus imports). The EUs relationship with Japan is also of high importance. The EUs focus here is on the need for Japan to open up its market more to European goods and investments and to get the government to take effective action to reflate the economy. The EU is also negotiating the establishment of a free trade area with the six members of the Gulf Cooperation Council (GCC), which is the regional organisation grouping Bahrain, Kuwait, Qatar, Oman, Saudi Arabia and the United Arab Emirates. It is examining ways of promoting bilateral economic relations with Iran through a trade and cooperation agreement which is under negotiation. In addition, the EU has concluded partnership and cooperation agreements with Russia and a number of other countries of the former Soviet Union Azerbaijan, Kazakhstan, Kyrgyzstan, Moldova and Ukraine. The agreements with Moldova, Russia and Ukraine are part of a process that Trade FTA to existing ASEAN, India South Korea,

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could lead to the establishment of a free trade area between them and the EU. (Jeffrey, 1998) The EU has recently been very active in its trade relations with Latin America. A free trade agreement with Mexico came into force in July 2000. This agreement will give EU exports the same access to the Mexican market as those coming from the United States and Canada, its partners in the North American Free Trade Agreement (NAFTA). The EU is scheduled to remove all duties on imports from Mexico by 2003, while Mexico will lift all duties on EU goods by 2007. Together with Chile, EU has recently concluded the negotiations for an association agreement, delivering the most ambitious and innovative results ever for a bilateral agreement by the EU. Negotiations are currently under way to liberalise trade with Mercosur, the South American Common Market consisting of Argentina, Brazil, Paraguay and Uruguay. The EU is already the most important trading partner of the Mercosur countries and the biggest foreign investor in the region. The negotiations will cover not only the liberalisation of trade in goods and services, but also public procurement, intellectual property rights, competition policy and foreign investments. South Africa concluded a bilateral agreement with the EU on trade, cooperation and development in 2000. According to this agreement, within 12 years, South Africa and the EU will grant free trade status to each others exports(Brlhart & Matthews, 2007). The deeper integration proposed by the EU should result in

improvements in regulation and competition. In particular bilateral measures that promote enhanced transparency and regulatory best practices are consistent with multilateralism. When it comes to specific regulatory norms or standards however, the EU should ensure that its FTAs seek enhanced compliance with existing international norms or standards rather than introduce specific new standards in the bilateral agreements. Also, to be emphasozed is that globalisation of trade must

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not attack poorer countries. The EU wants to commit and find ways of helping these countries to catch up with the rest of the world, and running away from poverty trough trade. Improving their access to global markets for agricultural and industrial goods and services is crucial for its further development.

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III. FOREIGN DIRECT INVESTMENT

This part of the report will be concerned with foreign direct investment (FDI) activities of the European Union. Firstly, a brief introduction to the concept of FDI will be given in order to provide the reader with a solid understanding for the upcoming chapters. Secondly, EU outward and inward FDI stocks and flows will be analyzed and explained. Furthermore, an analysis of the economic activities the investments were made in is covered in the upcoming chapter.

A.

INTRODUCTION TO THE CONCEPT OF FDI

One of the main characteristics of the world economy and the globalization was a tremendous rise in foreign direct investments (FDI) of multinational companies in foreign lines of businesses over the past 20 years (Raff 2006). This was mainly done by founding a subsidiary abroad or by investing substantially in existing companies. While the worldwide GDP has tripled during that time, FDI flows have increased more than thirty times, which points out again the rising importance of this method of investment (Raff 2006). Furthermore, a large number of controversial theoretical approaches and surveys about the determinants and consequences of FDI show the high economical and also political interest in the topic. This is spurred by the fact that this form of investment has become one of the most important sources of finance for foreign companies and states, since it covers for a vast proportion of their capital needs (Groht 2005). The following section of this paper tries to give a comprehensive overview on theoretical approaches to FDI in order to provide the reader with a solid understanding about the concepts involved.

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1.

What is FDI?

According to Groht (2005) a financial situation can be classified as foreign direct investment if an investor directly holds more than 10 % of the shares of a company including their subsidiaries and branches. Also all subsequent transactions between affiliated companies can be regarded as FDI (Eurostat 2007). However, for some economists the striking characteristic of FDI is that the financial relationship involves also a degree of control. In this scenario, a foreign subsidiary does not only have financial obligations against its parent enterprise but is also part of the organizational structure. This is also advantageous for the controlled company, since a long-term business relationship can be expected (Krugmann 2003). In fact, FDI can be made in various forms. Firstly, a new company in the target country can be founded which is called a Greenfield-Investment. Secondly, an alternative is to take over an existing company or buy at least 10 % of their shares. This method, commonly referred to as Mergers and Acquisitions is the most common form of FDI worldwide. However, if we have a closer look at developing countries, one will discover that Greenfield-Investments rank first, while also Mergers and Acquisitions are becoming more popular. Thirdly, credits and any other form of financial benefits which strengthen the financial power of the foreign company are regarded as FDI (Groht 2005).

2.

Why does FDI take place?

There are two main reasons why investors engage in direct investment relationships: vertical and horizontal FDI. Clearly, also a mixture of these two forms is possible and in fact rather likely (Eurostat 2007). Both Greenfield-Investments and Mergers and Acquisitions can be further split up into horizontal and vertical FDI. If both parent company and subsidiary produce the same good or service the underlying relationship is horizontal. This method is often used when markets are

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highly competitive and import costs are too high in order to participate effectively. Then horizontal FDI acts as a substitute to trade providing the investor with strategic market access and reduced delivery time (Eurostat 2007). Nevertheless, if a company splits its production chain up sourcing intermediate products from countries with lower costs we can speak about a vertical investment which is carried out in the form of a value chain (Otto 2005).

3.

Advantages of FDI

There are several advantages arising from FDI that cause investors to engage in this method of investment. From the investors point of view, FDI is a reasonable way of entering a new market and of gathering experience in it. Furthermore in some service industries (e.g. banking) a local representation of the company can be a prerequisite for serving the market. Last but not least, lower input costs for labour, raw materials or intermediary goods often play an important role in the decision whether to invest in a foreign country (Eurostat 2007). Nonetheless, FDI entails not only benefits for the investor, but also for the investee. Most importantly, the direct investment enterprise can expect a long-term relationship with the investor. FDI flows are less liquid and tradable than portfolio investments and hence less volatile. Especially in the case of emerging countries, this fact decreases the risk of speculation and liquidity crises. Moreover, as FDI increases the competition in the target country it is likely that also its rivals improve their efficiency and product quality. The foreign expertise might also lead to technology spillovers, influence management skills and employment and consequently growth (Eurostat 2007). At this point it needs to be pointed out that FDI has not only advantages but also downsides like increased economic and political dependence or possible externalities on the labour market (Economy Watch 2010).

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However these disadvantages are outweighed by the positive effects of FDI and hence shall not be further discussed in this paper.

4.

Theoretical explanations of FDI

There are numerous research papers trying to explain the reasons for direct investments across borders. This part of the paper tries to give a brief and comprehensive explanation for the existence of FDI using trade models.

a)

Neoclassical theories

The first attempt to explain FDI was Ricardos theory of comparative advantage. Nevertheless, this theory failed to explain the rising share of FDI. In fact, the theory, which is based on two countries with two different products and immobile production factors could not even allow FDI. Also the Heckscher-Ohlin model which is built on the Ricardian model faces the limitations of immobile production factors. Consequently, other models such as the portfolio theory were used to describe the ongoing situation. Also this attempt failed since the portfolio theory only explains foreign investments as part of a portfolio and not directly (Hosseini 2005). Interestingly, international investments were not really common at the time those classic models were invented hence there was no need for them to explain the rationales behind FDI.

b)

Production cycle theory of Vernon

Vernon came up with his production cycle theory in 1966 which was another attempt to capture foreign investments in a model. He believed that there are four stages of production cycle: innovation, growth, maturity and decline. In the first stage of the production cycle a multinational company has an advantage by possessing new technologies but as the product is launched also the technology is known. Therefore the

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initial producer starts to standardize the product and others will copy it. This forces the multinational firm to perform production facilities on the local market in order to compete with its competitors in terms of costs (Vernon 1966).

c)

The Eclectic Paradigm of Dunning

Basis of this theory developed by professor Dunning is the existence of different advantages and prerequisites in order to engage in FDI (Dunning 1973). Ownership advantages: This refers to intangible assets, such as unique technology, certain management skills or simply a patent or brand owned by the multinational company, which give a strong competitive advantage at the foreign market. Location advantages: A production facility abroad has a location

advantage compared to site at home which makes it more favorable for the company to shift its production abroad. This can be determined by the political framework (subsidies), cost advantages or also trade barriers (quotas, tariffs). Internalization advantages: Supposedly the first two advantages exist then it must be worthy for the company to use these advantages in collaboration with some factors outside the country of origin. A reason might be the existence of market failures producing costs that are higher than shifting production to the foreign country. The theory states that only if all three advantages exist at the same time an investor will engage in FDI (Dunning 1973).

d)

Conclusion

Empirical evidence shows that there is not a unified theory which is capable of fully explaining FDI and it is unlikely that such a theory will emerge in the future.

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However, neoclassical theorists could not explain the existence of Multi National Corporations. The underlying theories were able to define portfolio investments by looking at interest rate differences in two countries but failed to show causes for FDI. Vernon stated in 1966 that it is the competitors who set essential incentives that make a company invest abroad. Empirical evidence, though, show that there was not always a clear link between FDI and technological advantages but investments were still made. Finally, after various neoclassical attempts to explain FDI Dunning proposed a conceptual framework which was widely accepted in the literature. Although also his theory had some weaknesses it was used until very recently.

B.

OVERVIEW ON FDI ACTIVITIES OF THE EUROPEAN UNION

In 2006 world FDI inflows (excluding intra-EU flows) accounted for EUR 774 bn which meant an increase of 56 % compared to the previous year. Interestingly, in this very year the EU overtook the United States in terms of FDI inflows receiving about 20 % of the worlds total (USA 18 %). Furthermore, while the share of inflows to developing countries droped slightly the amount of direct investments made in developed countries increased to 54 % (Eurostat 2008).

Table 1: World FDI flows by recipient, 2001-2006, EUR bn, Source: Eurostat 2008

Regarding the world FDI outflows by investor country it is obvious that developed countries account for the largest share with approximately 80 % of the total flows in 2006. The share of the EU was with 34 % slightly bigger than the amount invested by the United States. Compared to 2005

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this meant only a slight increase which is due to the extraordinarily high share in the previous year.

Table 2: World FDI-flows by origin, 2001-2006, EUR bn, Source: Eurostat 2008

1.

EU direct investment abroad

Since 2002, direct investments made by the 27 member states of the EU increased to EUR 260.2 bn in 2006. More precisely speaking, this is an increase of 11 % compared to 2005 and is the highest level reached since 2001 (Eurostat 2008). 55 % of EU FDI outward flows went to the American continent in 2006 which is a total of EUR 141.9 bn in absolute terms. Unsurprisingly, the United States accounted with 28 % for the majority of total EU FDI outward flows followed by Canada with 12 %. Non-EU Europe attracted investment flows of EUR 66.8 bn (26 %) in 2006. This is a drastic decline relative to the previous year but only because there was such an extraordinarily high investment flow in 2005 which was due to a recovery of flows to Switzerland. In 2006, Switzerland ranks third as a target country for EU outward investment receiving 8 % of the total flows.

Table 3: Extra-EU outward flows, by main continents, EUR bn, Source: Eurostat 2008

Regarding EU FDI outward stocks the distribution on the different continents is quite similar. North America ranks first with 39 % of total stocks followed by non-EU Europe holding 22 %. As can be seen on the following table Africa and Oceania remain very unattractive for EU FDI.

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Consequently only 5 % and 3 % respectively of the investment stock is allocated in those continents.

Table 4: EU-25 FDI outward stocks by main destination, Source: Eurostat 2008

Main investors among the member states are the United Kingdom, France and Germany. These three accounted for considerable 45 % of the total outward stock. While the most important partner of all three countries is the United States, France also has a large share of investments in Switzerland (9 %) and Japan (8%) (Eurostat 2008).

2.

Direct investment in the EU

The EU is a fairly attractive region for foreign countries to invest in. Although direct investment in the EU experienced a sharp decline in 2004, FDI inward flows jumped by 118 % and 24 % respectively in the following two years resulting in a total of EUR 157.1 bn in 2006. Concerning the distribution of this amount the picture is quite similar to the one gained from outward investments. The United States is with 48.1 % by far the leading investor which equals a total investment of EUR 75.6 bn expressed in absolute numbers. This position was strengthened by big strategic deals that were put in place in 2006. These included acquisitions in the field of telecommunications, hotels, banks and pharmaceuticals (UNCTAD 2007). Switzerland ranks second (10.6 %) and Japan (8.7 %) takes the third place in this statistics. Interestingly, if we have a more aggregated look at the origins of EU inward investment it is obvious that also Asia has a considerable interest in European investments. In fact, Asia was the second largest investor in 2006 with a share of 19 % compared on a continental level.

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Table 5: Extra-EU inward FDI flows, by main continents, EUR bn, Source: Eurostat 2008

Furthermore, it is worth mentioning where these FDI inward stocks exactly went to. As a matter of fact, the United Kingdom was by far the major recipient in 2006 hosting 19.5 % of the total stocks. The Netherlands is the second most attractive country for foreign investment (8.5 %) closely followed by France (7.9 %) and Germany (7.8 %) regarding FDI inward stocks. With a closer look to FDI inward flows it becomes evident that also Luxembourg is an attractive country for foreigners to invest in. In this statistic the small country ranks second with a share of 20 % of total inflows. The reason for the countrys importance can be easily explained by its position as a centre of financial intermediation activities (Eurostat 2008).

Table 6: Share in EU-27 FDI inward flows from extra-EU 2004-2006, Source: Eurostat 2008

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Eurostat 2008, European Union foreign direct investment yearbook 2007, Luxembourg. Groht, V. 2005, `Warten auf den Boom Direktinvestitionen in den osteuropischen Beitrittslndern`, Wunschdenken und Fakten, Berlin. Hosseini, H. 2005, An economic theory of FDI: A behavioral economics and historical approach, The Journal of socio-economics, 34, pp. 530-531. Krugmann, P. R. 2003, Internationale Wirtschaft, 6. Aufl., Mnchen. Otto, A. H. 2005, Makrokonomische Effekte der Direktinvestitionen, in Hasse, Band 33, Frankfurt am Main. Raff, H. 2006, `FDI: Theory and Evidence`, Institut fr Volkswirtschaftslehre an der Christian-Albrechts-Universtitt zu Kiel, [Online], Available: http://willmann.com/~gerald/awsem/voss.pdf [30 October 2011]. UNCTAD 2007, World Investment Report 2007, [Online], Available: http://www.unctad.org/en/docs/wir2007_en.pdf [15 November 2011]. Vernon, R. 1966, International investment and international trade in the product cycle, Quarterly journal of economics 80, pp. 190-207.

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Chen, N. 2002, Intra-national versus international trade in the European Union: Why do National Borders Matter, Discussion Paper No. 3407, Centre for Economic policy research, London. Conconi, P. 2009, The EU common commercial policy and global/regional trade regulation ULB Institutional Repository 2013/13344, ULB, Universite Libre de Bruxelles, Bruxelles. Council of the European Union, 2007, General Secretariat, Enhancing EU support for trade-related needs in developing countries, Brussels. Cremona, M. 2002, The external dimension of the internal market, The Law of the Single European Market, Oxford University Press, p. 354-355. Cremona, M. 2011, External Relations and External Competence of the European Union: the Emergence of an Integrated Policy, Oxford University Press, 2nd edn, chapter 9. Deutsch, K.G. 1999, The politics of freer trade in Europe, Center on Transatlantic Foreign and Security Policy Studies, Freie Universitt Berlin, Department of Political Science, Munster. European Commission 2003, Reviving the DDA Negotiation the EU Perspective Communication from the Commission to the Council, to the European Parliament and to the Economic and Social Committee, Brussels. European Commission 2011, EU Trade Policy towards Developing Countries, [22 October 2011] European Parliament, [Online], Available: [Online], available: http://trade.ec.europa.eu/doclib/docs/2010/february/tradoc_145762.pdf

http://www.europarl.europa.eu/sides/getDoc.do? pubRef=-//EP//NONSGML+COMPARL+PE456.679+01+DOC+PDF+V0//EN&language=EN [29 October 2011]. European Union, 2008, Consolidated version of the treaty on the functioning of the European Union Official Journal of the European Union, (C 115/47), 47-200.
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Hohler, W. 2002, Issues of US-EU trade policy, Working Paper, Institut fr Volkswirtschaftslehre, Linz. Holmes, P. 1991, Europe 1992: From the Common market to the Single Market Politicised economic choice, Lancaster. Kleimann, D. 2011, Taking Stock : EU Common Commercial Policy in the Lisbon Era, Policy Analysis, Bruxelles. Krajewski, M. 2010, The Reform of the Common Commercial Policy, in A. Biondi and P. Eeckhout (eds), European Union Law after the Treaty of Lisbon, Oxford: Oxford University Press, (forthcoming). Limo, N. 2007, Are Preferential Trade Agreements with Non-trade Objectives a Stumbling Block for Multilateral Liberalization? Review of Economic Studies 74, 821-855. Organisation for Economic Co-operation and development, 2011, [Online], available: http://www.oecd.org/home/ [21 October 2011] Vamvakidis, A. 1998. "RTAs versus Broad Liberalisation." International Monetary Fond. WP/98/40. P. 29. Woolcock, S. 2005, European Union trade policy: domestic institutions and systemic factors, In: Kelly, D. and Grant, W., (eds.), International political economy series. Palgrave, Basingstoke, UK, pp. 234-252. Young, A. & Peterson, J. 2006, The EU and the new trade politics Journal of European Public Policy, pp 795-814.

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