vo.12,No.23) ANALYSIS C Monetary Union ll Is Europe One Market? As early as 1978 the European Council set up the Eu Overview of Previous Research ropean Monetary System(EMS) to solve the problem o monetary instability and to foster cohesion among The brief review of the history of European market member states. Established on a voluntary and differen- integration shows that the legal and political barriers tiated basis, the EMS depended on the existence of a that would have prevented market integration have ommon currency unit, the ECU. Through the Treaty or been removed or greatly reduced. However, what are European Union, a European System of Central Banks, the actual economic results of the EUs efforts toward a European Central Bank, and a European Investment ntegration? In other words did the elimination of mar- union were to finalize the completion of the single etary ket barriers actually lead to closer economic relations Bank had been set up The main aims of mor and to increased activities between compa ket by removing the uncertainty and costs inherent in consumers in the EU member states? If economic be currency-changing transactions, as well as costs of havior followed the policy initiatives, one should ol hedging against the threat of currency fluctuations, and serve market results, particularly prices for goods and by ensuring the total comparability of costs and prices services, costs for factors of production, and-most im- hroughout the Union By facilitating business and helping consumers, the profitability among the EU national economies converg EMS was expected to stimulate intra-Community trade ing. Briefly surveyed next are studies that have investi nd increase economic activity to reinforce Europe's gated the economic impact of the EU single market pro- monetary stability. The stages of EMU during the 1990s were intended to phase in the transition to the single In evaluating the impact and outcome on eU market cur ncy so that results, one must consider that even in markets that are particularly through the prior achievement of considered fully integrated--for example ough convergence of economic and monetary policies States--regional market differences exist 3 the United Profit ability between geographic regions within states migh D. Harmonization of Legal Framework especially be driven by factors such as regionally differ phic conditions, market size To further support the integration of the European competitive situat vailability of substitute goods market, rules on competition were introduced that fo- levels of supply and demand, consumer purchasing cused on the following areas: competition policy and power, the nature and extent of government regulation concerted practices; abuse of a dominant position and production costs, and transportation costs. 0 In general a main difference between markets that are not consid akings and services of general interest. Moreover, Eu ered integrated and those that are considered to be in- member states'legislation were brought closer to a tegrated is the existence of regulatory and technical ommon base to promote economic cohesion, particu narket barriers that prevent or restrict economic activi larly in the areas of public contracts, company law ties between the markets by, for example, imposing banking, insurance and securities, intellectual, indus- CroSS-border transaction costs. As discussed above duties(alcohol and tobacco), energy taxation, personal in the EU market by the single market prograln moved and company taxation, and fiscal policy. Apparent market differences might also be induced Some issues regarding the letion of the internal by diverging regional preferences or by industry con market are still open. These include plans for further le factors that are not necessaril lated to market integration. For example, the concen statute for the European company, full freedom of facturing in certain regions is more likely a result of tax harmonization. Moreover, certain directives are not yet fully adopted in all member states, including those centration. These types of regional concentrations ar on public contracts, transport, and intellectual property also observable in economies that are considered fully n addition, further harmonization measures focus on integrated, for example, computer-related sectors with relatively lower levels of integration(such trated in the rust belt in the Midwest United States concentrated in Silicon Valley or steel industry concen- as the retail finance sector) similar l E. Conclusion that might be provided by local government withi states. Therefore, the relevant economic question is not The history of the European single market demon whether differences between markets exist, but how strates that the majority of market barriers that have significant these differences are and whether they are their origin in the separation of European markets more considerable than those observed in markets that through national borders have been abolished. More- are considered fully integrated over, national economic and monetary policies, the le Several studies have examined the impact of th gal framework for economic activities, and national ingle market program and the degree of integration egulations have been largely harmonized or are about be harmonized. Therefore, the authors believe the le gal and political framework for European economic in- 9 In this paper, "region"refers tegration is already in place, and it is reasonable to con- ider tests of Europe as one market for transfer pricing his list of factors that might constitute differences be- purposes tween market results foilows the OECD guidelines. These fac tors are discussed in more detail in section lll of this paper. 414C4 Copyright- 2004 TAX MANAGEMENT INC, a subsidiary of The Bureau cf National Affairs, Inc. TMTR ISSN 1063-2069
ANALYSIS reached in the European market, with the goal of as- For most goods, the overall price dispersion is much sessing whether EU markets are highly integrated eco- arger in the United States than in the European Union. omic markets where economic activities of market Moreover, price dispersion for tradable goods in the Eu articipants are highly interdependent across national ropean Union was reduced by 50 percent between 1990 borders. This question has different interrelated as- ferential in the European Union in comparison to other a Does market integration lead to a convergence of OECD countries. 4 They report that the border effect in the price formation process, and do prices of goods and the European Union is significantly lower than that ob services and production costs in the different EU coun served between Canada and the United States tries therefore converge? n Have trade flows between the states'markets been convergence among EU member states. Its studies increased and become as intense as intrastate trade? show price convergence during the 1990s, but a decel Are European capital markets becoming more in. erated convergence process since 1997. Most notably, tegrated and do interest rates in Europe converge? a As a result of increased market integration, are the tions. Moreover, price convergence among the six returns of European companies converging andfor is ounding member states is very tight the variability of their profitability decreasing relative to B Intra-EU Trade flows The following briefly reviews the results of studi Trade flows among EU member states, measured that examine these questions relative to gross domestic product increased signif cantly since the early 1990s. Moreover, trade border A Price Convergence effects. which measure whether international trade de viates from intranational trade, seems to have An indicator of the degree to which EU markets have creased substantially from the late 1980s to the integrated is price convergence, or the degree to which 1990s. This indicates that the market has become much prices for the same goods or services have come close more integrated through the single market progr together. Price convergence is expected to be more The European Commission reports steady growth of closely aligned when trade flows between the me states are high, since increased trade flows suggest that cent of EU trade. 17 Only trade in the services sector is arbitrage betwe low; further integration in the services sector would re- can occur. However, because prices also differ within a quire the more intensive application of mutual recogni en member state the determination of the degree of orice convergence among the EU member states re- quires the economist to measure price convergence be C. European Financial Market Integrati tween states on a relative basis, for example relative to the degree of price convergence in other integrate The Euro area government bond market is consid ed highly integrated. The elimination of exchar rate risk led to a significant convergence in bond yield a recent study of international price comparisons among the Euro area member states althe ough minor to evaluate the existence of price convergence in the vield spreads have persisted mainly due to still existent EU, researchers concluded that price differences within institutional and size factors. The 19 integration of the erbank market is goods, the researchers found that price differences be- tween the United Kingdom and the rest of the eU were bodies and regulators. Europe's between supervisory corporate bond grew ences gnificantly at the ample, the EU and the United States. In another study However it suffered under difficult market conditions commissioned by the U. K. government, ACNielsen con- d increased investment risks during the last twc cluded that for the bulk of goods for which comparisons could be made, there was no significant difference in Integration appears to be still in process in prices between EU member countries, as price diffe ket, the corporate loan market and ences were not larger than the spread of prices within market conditions. However, in general, the he countries. I financial sector experienced a significant If one compares the degree of price dispersion in the United States to that in the European Union, the Euro- pean Union seems to have come very close to the de- +4 A de serres et al., The width of the Intra- European E gree of price convergence found in the United States. 13 nomic Borders, OECD ECO/KP(2001)30 intemal market en update/ agen Economics, p. 17 if. I See haskel and Wolf. "From Big Macs to iMacs: What Do ning of EU Product See ACNieisen, A Report on International Price Com Adam et al. Analyse, Compare, and Apply Altermative In Copenhagen Economics: The internal market and the rel- dicators and Monitoring evant geographic market, 2003, p 21 ff tion of Capital Market Integration, Salerno 2002 TAX MANAGEMENT TRANSFER PRICING REPORT ISSN 2C63-2069 ENA TAX 4-14-04
s8(vol.12,No.23) ANALYSIS change, with deeper integration of national markets profit indicators measured, EU variances in profitability ents and intermediaries. 20 s always lower than that of Japan, but not always lower In equity markets the introduction of the Euro elimi- ROA for the EU chemical industry has a lower variance border equity investments. l Internationalization of eg: from this analysis that the variance of profitability in border mergers and acquisi the European Union is not generally higher than that of tions, and the consolidation of stock exchanges have other markets considered fully integrated, particularly enforced cro sS-border activities. In addition it is also Japan. Therefore, based on their analysis, there is no evident that investor behavior has changed fror country-based toward cross-border investments. Al reason to conclude that company profits in the euro- pean Union are more dispersed than in other fully inte though national differences between stock markets re- main with respect to market capitalization and the A comparison of the profitability spreads between number of initial public offerings(IPOs)22 these are enterprises of different size(small versus large)on the probably more an indication of in ncreased regional spe cialization and concentration of equity markets (ex basis of the BACH database results in a considerably lower profit spread for the observed eur hanges) in an integrated European market. However, tries than in Japan and the United States. 2 The same due to the liberalization of capital markets and global study also compares profitability results among differ zation, the market for wholesale financing has devel ent European countries. However, because no statistical oped substantially and has become more integrated and test is applied the results are difficult to interpret, and ompetitive. It seems that larger companies in particu- no clear result regarding profit convergence can be de- lar have access to international financing markets rived. An extensive study of financial structure and whereas only very small firms still depend on their local profitability based on the Bach database does not de- financial system." rive results regarding the comparability of European companies'profits either, and therefore does not con- D. Profit Convergence tribute to the authors' investigation 30 The same conclu- sion applies to a study of the German Bundesbank com- (defined as profits after operating ex hich finds that be. s)convergence by independent companies oper- cause of diverging financial structures this PlI does not the eu member states is the mea provide a reliable basis for international profitability convergence that is most consistent with the transfer pricing question "Is Europe One Market? ""for the appli Criton and Walton examine the ratio of profits to ation of the TNMM and related transfer pricing meth capital employed of Euro-area countries and their ma- ds. Although no research was found that directly ad- or trading partners and concl dresses this question from a transfer pricing perspec ive, there is research that investigates company furthe ged in the Euro area, 3a houe that profits have not described (unclear database and num profitability within the EU and compares and contrasts re, the authors cannot the findings to those in other significant markets, such evaluate how representative their results are. Further as the United States and Japan more, their conclusions are not based on statistical Meric et al. compare the profitabi of Japanese, EU tests. Moreover, their profit level indicator seems to be and U.S. manufacturing firms operating in three major based on an arbitrary determination of the asset base manufacturing industries(chemicals, industrial In addition, their potential explanations for the devia hinery,and electronics)over the 1996-2000 period. 2-4 tions (investment flows are insufficient to reduce profit the operating profit margin (OPM,and the return on area, that is, EU Company data constitutes one sample which using a multivariate analysis of variance. 2One of the is compared to the U.S. and the Japanese data samples findings is that, for the ROA, OPM, and other relevant aged by the European Commission(DG for Economic and Fi- zed Databank"is ncial Affairs). It contains aggregate and harmonized infor 2o See"Commission of the European Communities, The covers 11 European countries, Japan and the U.S. for the years Euro Area In The World Economy-Developments In The First 1990-1996. It includes less than /40, 000 European companies Three Years, "p, 30 ff n of the European Communities, p. 34 f The data is mainly provided by Central banks or Ministries of See Et the respective policy, Rest the 2002 scoreboard, SEC (2002)1213 Commission, Directorate-General For Economic and Fiscal Af an Commission, Directorate-General For eco- Than Meric et al."A Comparison of the Financial Char- nomic and Fiscal Affairs, Supplement A, No 11/12,1998 acteristics of U.S. E U, and Ja Firms mparison Between the Finan The OPM is the ratio of operating profit (profits related to operating activities before interest and taxes) to sales. Ope Using the BACH Database, " Economic Paper,Nr155,July ating profits and net profits are used interchangeably in this 3I The ROE is equai to a fiscal year's after-tax income di The ROA is equal to operating profit (profits related to vided by the book value of equity operating activities before interest and taxes) divided by aver- lur Unternehmensrentabilitat They use the Disclosure Worldscope database for the riton, Laura, Walton, Richard:"International Compa analysis. The EU is considered as one integrated economic 2002 on of Company Profitability, " Economic Trends, No 587 1404 Copyright 2004 TAX MANAGEMENT INC, a subsidiary of The Bureau of National Affairs. inc. TMTR SSN 1063-2069