Abolishing the Schengen Agreement potential effects on intra-EU trade in goods

After comparing the effects of the single market and the Schengen Agreement on trade within the European Union, it can be seen that Schengen does not provide any remarkable additional be

Abolishing the Schengen Agreement: Potential Effects on Intra-EU Trade in Goods - Evidence from the Transport Sector in the Austrian-German Border

Univ Prof Dr Christoph Moser

Salzburg, August 2018

I hereby declare that the Master thesis submitted is my own and unaided work All sources used are acknowledged as references All parts quoted directly or indirectly from other sources have been indicated accordingly

This paper was not previously presented to another examination board

Abstract i

List of Abbreviations ii

1 Introduction 1

1.1 Background and Relevance 1

1.2 Objectives 2

1.3 Outline, Research Questions and Methodology 3

I EU Single Market, Borders and Trade 5

2 The European Single Market 5

2.1 Historical Developments 5

2.2 Legal Framework of the European Single Market 6

2.3 Single Market: Theory and Practice 10

3 The Schengen Agreement as part of the SMP 15

3.1 Historical Developments 15

3.2 The Schengen Agreement: A legal perspective 16

3.3 Schengen effects on intra-EU trade 18

3.4 Current Challenges of Schengen: The 2015 Refugee Crisis 23

II Abolishing Schengen: Potential Effects on intra-EU trade 26

4 Findings of current studies on non Schengen 26

5 Evidence from the Transport Sector in the Austrian-German border region 29

5.1 Methodology 29

5.2 Data 32

5.3 Results 33

6 Discussion 33

7 Conclusion 38

References 43

Annex I: Questionnaire (German version) 50

Annex II: Questionnaire (English version) 54

Due to Schengen I and Schengen II, internal frontiers and border checks within the European Union had been abolished by 1995 However, the 2015 refugee crisis has urged several EU member countries to reintroduce controls at their borders A famous example of such border controls is the ‘Walserberg’, a border crossing connecting Austria and Germany The paper

on hand exploits the case of these temporary controls at the Austrian-German border to examine the impacts of a potential permanent suspension of the Schengen Area on intra-EU trade in goods, with a special focus on non-Schengen effects on the transport sector in the Austrian-German border region After comparing the effects of the single market and the Schengen Agreement on trade within the European Union, it can be seen that Schengen does not provide any remarkable additional benefits to the single markets’ positive effects on intra-

EU trade Even though, the carried out quantitative case study research does not allow to present any empirical results due to a lack of participation, reviewing recently published relevant literature allows supporting the hypothesis that Austrian transport companies are facing higher operational costs for their intra-EU activities due to the reinstalled border controls between Austria and Germany The thesis shows that the Schengen Agreement neither provides additional benefits to trade within the European Union, nor would an abolition of the Schengen provisions lead to striking negative effects on intra-EU trade in goods However, the Schengen Agreements’ political value has to be emphasized and needs

to be considered when discussing its potential permanent suspension

Keywords:

Schengen Agreement, Cecchini Report, single market, border controls, Gravity Model, refugee crisis, transport sector, European Union

L

AVTE = Ad Valorem Tax Equivalent

CU = Customs Union

EC = European Community

EEC = European Economic Community

ECJ = European Court of Justice

EMU = Economic and Monetary Union

EOS = Economies of Scale

EPRS = European Parliamentary Research Service

EU = European Union

FDI = Foreign Direct Investment

FTA = Free Trade Area

GDP = Gross Domestic Product

IGC = Intergovernmental Conference

SEA = Single European Act

SMP = Single Market Programme

TEU = Treaty on European Union

TFEU = Treaty on the Functioning of the European Union

QMV = Qualified Majority Voting

VAT = Value Added Tax

WKÖ = Wirtschaftskammer Österreich (Economic Chamber of Austria)

1 I

The thesis on hand focuses on potential effects of abolishing the Schengen Agreement on intra-EU trade in goods with a special focus on impacts on the Austrian transport sector Divided into a theoretical and empirical part, the thesis uses recent empirical literature on non-Schengen scenarios as well as gathered empirical data to answer the posted research questions, providing considerable results for the debate on a permanent suspension of the Schengen Agreement

The following introductory chapter explains the background of the topic, shows why the issue

is relevant and provides an overview of the thesis’ structure as well as the used methodology

1.1 Background and Relevance

Starting in the early 1950s, cooperation among the European countries finally resulted in what

we today call the European Union However, the forgoing integration process, bringing the national states together, took decades Following the European Economic Community, founded by the Rome treaty in 1958, the European customs union went into force ten years later Until the late 1970s, however, only little further progress towards European unity had been made1 Therefore, pushed by the EC Commission through its 1985 white paper on

‘completing the internal market’2, several steps towards closer cooperation had been taken, resulting in the creation of the European Union through the Maastricht Treaty in 1993 Further, by 1995 it could be managed by the so called ‘Schengen I’ and ‘Schengen II’ agreements, to abolish any internal frontiers within the European Union and hence, all controls at borders within the EU3 For two decades, European citizens could travel through the territory of the European countries without being controlled at any border

In 2015, however, the so called ‘refugee crisis’ reached peak with some 1.3 million refugees entering the European Union4 Soon, several member countries felt themselves urged to react individually, suspending the Schengen Agreements’ provisions and reinstalling temporary controls at internal borders5 While the Schengen Borders Code6 allows doing so in exceptional circumstances, the European Commission further approved the renewal of the temporarily introduced border controls several times Hence, today six countries (France,

see Phinnemore, 2010, p 19; Fligstein & Mara-Drita, 1996, p 13; & Guild et al., 2015, p 2

4 see European Parliament, 2018

Austria, Germany, Denmark, Sweden and Norway) still protect their borders to other EU member states These controls will last at least until November 2018 but may then be renewed again.7

Besides the expected national positive effects regarding migration inflows and national security, negative aspects of the re-established border controls soon became visible In particular, the road haulage sector had to deal with hours of additional waiting times putting just-in-time transport and supply-chains under pressure In September 2015, the Wirtschaftskammer Österreich estimated additional costs for the Austrian transport sector of some € 2.4 million every day8 But also commuters and travellers were negatively affected While three years later, waiting times at intra European borders still cause delays and additional costs, a debate had been opened whether a permanent suspension of the Schengen Agreements’ liberalizing provisions would be beneficial for the member states in order to control migration inflows and maintain their national security.9

However, both the European Parliament as well as the European Commission published studies and communications warning to do so, already in early 201610 Based on empirical research carried out by the Bertelsmann Stiftung (2016) 11 and Assiloux & Le Hir (2016) 12the corporate communication was that ‘Back to Schengen’ should be the solution strived for

in cooperation with the Wirtschaftskammer Österreich to a total of 1.500 Austrian forwarders and carriers The findings will then be put into consideration for assessing non-Schengen effects on intra-EU trade in goods

This allows contributing to the yet rather small existing literature on effects of suspending Schengen by adding new insights to recent empirical findings Yet, the empirical research carried out mostly focuses on non-Schengen effects at a EU- or member states level rather than scrutinizing impacts on individual economical sectors It will be shown, however, that instead of the Union or member states, in particular, specific branches suffer from border controls While this finding can actually be used as argument for both supporting as well as opposing a permanent suspension of Schengen, it is a noteworthy result that should be considered in the ongoing debates on the future of the Schengen Agreement

1.3 Outline, Research Questions & Methodology

In the further course, the thesis on hand will be structured as follows:

Since Schengen can be seen as part of the single market programme, the first chapter introduces the European single market Based on fundamental theories of European integration and economic cooperation it will be shown how and why the single market did emerge in the first place After presenting also its legal framework, the thesis continues with a literature based examination of the single markets’ effects on trade within the European Union

The second chapter concentrates on the Schengen Agreement Similar to the first part on the single market, the history of Schengen gets presented, touching also upon its legal context within primary and secondary EU law Based on empirical research, the impact of the Schengen Agreement’s liberalizing provisions on intra-EU trade will be shown Further, the current challenges the Agreement is facing will be elaborated, also presenting the reactions of individual member countries to the refugee crisis

As has been mentioned above, abolishing the Schengen Agreement is associated with additional costs and thus, may lead to negative effects on intra-EU trade However, discussions on suspending Schengen based on political reasons regarding migrant inflows or national security imply that, the Schengen Agreement is less valuable from an economic perspective and may be outweighed by political concerns Therefore, the first research question asks

Q1: ‘Is the Schengen Agreement as part of the European Single Market legit from an economic perspective regarding its additional benefits to intra-EU trade in goods? ’

While the thesis on hand does not touch upon the Schengen Agreements’ political perspective,

it nevertheless points out that the outcomes of a mere economic assessment of Schengen are not sufficient in order to base debates on the future of Schengen upon

As a first step, the results of the individual examinations on effects on intra-EU trade carried out in the first and second chapter of the thesis on hand will be compared Probing, the first hypothesis which states that

H1: ‘The Schengen Agreements’ liberalizing effect on border controls within the European Union does not provide any remarkable additional benefits to the EU single markets ’ positive effects on intra-EU trade in goods’

allows then answering the first research question

The fourth and fifth part of the thesis on hand concentrates on potential effects of abolishing the Schengen Agreement Presenting varying results of recent empirical literature on non-Schengen scenarios, the fourth chapter examines what effects a permanent suspension of the Schengen provisions would have on intra-EU trade The following fifth chapter contains the empirical part of the thesis

Exploiting the current real-world situation of border controls at the Austrian-German border, the paper uses a quantitative case study research design to examine the impacts of these controls on Austrian transport companies The data used for analysis was to be collected by a questionnaire containing 13 questions that had been sent out in cooperation with the Wirtschaftskammer Österreich to a total of 1.500 Austrian transport companies Distinguishing between the ‘Salzburg Group’ as primary research object and a control group, analyzing the data allows probing the second hypothesis which states that

H2: ‘Austrian transport companies are facing higher operational costs for their

intra-EU activities due to the reinstalled border controls between Austria and Germany ’

However, the studied data allows only identifying a correlation but not establishing a rule of causality In the sixth chapter, testing the hypothesis enables, in conjunction with the results

of the first research question, to answer the second research question, asking

Q2: ‘What potential impacts could an abolition of the Schengen Agreement have on trade in goods amongst members of the European Union considering effects on the Austrian transport sector? ’

Chapter seven concludes

I EU S

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2.1 Historical Developments

Already from the beginning of cooperation among the European countries after World War II, the desire for a single market had been at the core of European integration Signed in 1957, the Treaty of Rome did not only found the European Economic Community (EEC) but also

established the four freedoms (of persons, goods, services and capital) aiming at dismantling

barriers to trade As further steps towards a common market, the elimination of customs duties and quantitative restrictions in 1958 had been followed by a common external tariff, ten years later.14

Among the literature dealing with European integration, there are different theories on how and why the European single market did emerge in the first place; but also concerning how,

by the mid 1980’s, the existing common market had been extended

From a neofunctionalist perspective, initiatives on completing the internal market came from the Commission in collaboration with transnational groups rather than from national governments of the European Community (EC)15 The concept of ‘functional spillover’ provides an explanation of the development of the single market as a logical step further, stemming from common rules agreed upon by the member states before16

From an intergovernmental institutionalist perspective, however, national governments were the main initiators Following this state-centric approach17, the single market emerged from interstate bargains based on national preferences Among several alternatives on closer European cooperation, the demand for liberalizing the internal market had been found to be a common denominator throughout the EC countries18

While both explanations differ in their view of who were the main initiators extending the single market, however, they share a common assumption on reasons for initiative: A Europe

in crisis Economic downturns in many of the EC countries as well as political disputes and an increasing inability to respond to new challenges had led to a feeling of ‘Europessimism’ and

‘Eurosclerosis’ throughout the Community during the late 1970’s and early 1980’s19 Initiatives to overcome stagnation and prevent even regression of European cooperation eventually resulted in an extension of the single market However, since it took several years for the single market to be set-up the relevant milestones shall be briefly introduced

On request of the Council in 1985 the Commission of the European Communities drafted a white paper on ‘completing the internal market’, setting up a detailed timetable and action plan including ‘measures which are directly necessary to achieve a single integrated market’20 Stressing out the political and economical benefits of a single market21 the EC Commission made proposals for some 280 directives in order to create the desired single integrated market

by 199222 The white paper had eventually been unanimously approved at the Milan Summit

in June 198523

Following the approval of this so called ‘1992 programme’24, an intergovernmental conference (IGC) had been called by the end of 1985 which led to the ratification of the Single European Act (SEA) in February 198625 The document aimed at achieving an internal market as ‘an area without internal frontiers’, provided for institutional reform and included amongst others the shift to qualified majority voting (QMV) in the Council26

The establishment of the ‘European Union’ through the Maastricht-Treaty in 1993 had been followed by initiatives to further dismantle barriers to trade by introducing a common currency in 1999, creating not just an economic but also monetary union throughout most of the European countries27

As most recent measures to ‘boost growth and strengthen confidence in the economy’28, the European Commission has proposed two sets of actions in order to overcome missing legislation or administrative obstacles of the single market The so called Single Market Act I and II have been presented in 2011 and 2012, respectively

2.2 Legal Framework of the European Single Market

19 see Weiler, 1991, p 2456; Fligstein & Mara-Drita, 1996, p 10; Fligstein & Brantley, 1995, p.120; &

Moravcsik, 1991, p 33

20

EC Commission, 1985, para 17 and see Moravcsik, 1991, p 40

21 for example see EC Commission, 1985, para 8, 12, 24

22 see Egan, 2010, p 260; Fligstein & Mara-Drita, 1996, p 13

23 see European Commission, 1985; Moravcsik, 1991, p 41

The Treaty of Rome already provided the four fundamental freedoms and the creation of an internal market In the following, relevant provisions within the EU treaties and leading case law, concerning the establishment and functioning of an internal market and guaranteeing the four freedoms, shall be presented

Art 3(3) of the Treaty on European Union (TEU) claims the establishment of an internal market and elaborates its goals Art 26 of the Treaty of the Functioning of the European Union (TFEU) has to be read in conjunction with art 3(3) TEU, art 27 TFEU, art 114 TFEU and art 115 TFEU (approximation of laws) In paragraph 2 it states that:

‘The internal market shall comprise an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured [ ] ’

Further, art 4(2)(a) defines the internal market as an area of shared competence between member states and the European Union, falling under the principle of subsidiarity, according

to art 5(3) TEU, and the principle of proportionality, according to art 5(4) TEU

For a better overview on relevant provisions, in the following, those will be structured according to the four fundamental freedoms

Free movement of goods

Provisions on free movement of goods are based in art 28 to 37 TFEU within the second title

of part three of the TFEU on Union policies and internal actions, as well as in art 110 TFEU Art 28(1) establishes the European customs union and prohibits all customs duties (tariff barriers to trade) between Member States and, in conjunction with art 30, charges of equivalent effect According to art 34 and 35 also quantitative restrictions (non-tariff barriers

to trade) on exports or imports between Member States shall be prohibited Regarding tax provisions, Art 110 prohibits (in excess of that imposed on similar domestic products) any direct or indirect internal taxation on the products of other Member States

Due to discrepancies on the interpretation of ‘measures having equivalent effect’, used in art

34 and 35, the European Court of Justice (ECJ) ruled in its judgement on case C-8/74

Dasonville that

‘(5) All trading rules enacted by Member States which are capable of hindering, directly or indirectly, actually or potentially, intra Community trade are to be considered as measures having an effect equivalent to quantitative restrictions ’

Regarding further important case law on the free movement of goods, and in particular mutual recognition, case C-120/78 Cassis de Dijon29 as well as joined cases C-267/91 and C-268/91 Keck & Mithouard30, have to be mentioned

Exceptions to the prohibition of measures having an effect equivalent to that of quantitative restrictions can be found in art 36 and may amongst others be justified on grounds of public morality, public policy or public security

Free movement of persons

Regarding the free movement of persons, a distinction has to be made between free movement of workers and freedom of establishment The relevant provisions can be found in the fourth title of part three of the TFEU on Union policies and internal actions

a) Free movement of workers

Even since the 1957 Rome Treaty, the free movement of workers had been an important part

of European economic cooperation It is ensured in art 45 TFEU However, during the years the ECJ was confronted with several cases concerning the notion of ‘worker’ In its case law31

the Court settled three criteria on how to assess whether a person may be considered as worker:

‘The essential feature on an employment relationship, however, is that for a certain period of time, a person performs services for and under the direction of another person in return for which he receives remuneration ’

In further case law32, the Court clarified that the worker status is independent from working hours and level of remuneration33 Moreover, workers who get unemployed do not immediately loose their status as worker34 and job seekers may be considered as workers up

to six months35

As secondary legislation, Directive 2004/38/EC36 (EU citizenship directive) deals with the right to move and reside freely on EU territory for all European citizens and their family members (under certain conditions)

Exceptions to the free movement of workers can be found in art 45 TFEU and may be subject

to limitations on grounds of public policy, public security or public health as well as due to specific provisions for the public sector

b) Freedom of establishment

Provisions on the right of establishment are based on art 49 to 55 TFEU In principal, any national of a Member State shall, under the conditions laid down for nationals of the country where the establishment shall take place, be allowed to

‘take up and pursue activities as self-employed person[ ] and to set up and manage undertakings [ ] ’ (Art 49 TFEU)

within the territory of any other Member State

As for free movement of workers, the freedom of establishment may be limited on grounds of public policy, public security or public health as well as due to specific provisions for the public sector

Freedom to provide services

With regard to freedom to provide services art 56 to 62 TFEU as well as Directive 2006/123/EC (services directive) become relevant

While art 57 sets out what is included by the notion of ‘services’, a cross border element is a further necessary condition Either the provider or the receiver has travelled and provided or received the service in a Member State other that in which he is established or resides An additional important condition for freedom to provide services is that it needs to be provided

on a temporary basis; otherwise it would fall under freedom of establishment

In conjunction with art 62, art 51 to 54 regarding amongst others limitations on grounds of public policy, public security or public health as well as due to specific provisions for the public sector, apply also on freedom to provide services

Free movement of capital

The free movement of capital is based on art 63 to 66 as well as 75 and 215 TFEU Art 63(1) states that

‘[ ] all restrictions on the movement of capital between Member States and between Member States and third countries shall be prohibited ’

Although, the Treaty does not provide a definition for what may be understood as ‘capital movement’, the nomenclature annexed to Directive 88/361/EEC37 provides clarification Restrictions on free movement of capital regarding to third countries may, according to art 66 TFEU be justified to safeguard against serious difficulties for the operation of economic and monetary union Art 75 allows for financial sanctions against individuals, groups or non-state entities in order to prevent and combat terrorism

2.3 Single Market: Theory and Practice

a) Theorizing the Single Market

In 1968, ten years after the Treaty of Rome, the members of the European Economic Community (EEC) decided to abolish tariffs and quotas on internal trade and eventually a Customs Union (CU) had been formed38 Although, the formation of the Customs Union had been only the beginning of what was still to come, establishing a CU is a big step for countries since it requires giving up individual sovereignty on setting external custom duties and choosing trade partners: While members of Free Trade Agreements (FTA) are free to set individual tariffs on external trade partners, members of CUs are bound to a common external tariff39 Another important distinction between CUs and FTAs is that members of Free Trade Agreements can autonomously decide to join other trade agreements CU members, however,

do not have this flexibility but all members of the Customs Union have to agree to become part of another agreement40 Even though, giving up parts of national sovereignty might cause costs, economical and political reasons, in sum, may outweigh these costs leading to benefits for participating countries41

Since its establishment in 1957, the European Union (back then EEC or EC, respectively) expanded continuously from six to 28 member countries, all joining the EU single market However, while some already became members of economic cooperation during the 1960s or 1970s, others remained outside the internal market until the 1990s or even the 2000s To expound what determines which countries trade with each other and would thus form a preferential trade bloc, the ‘gravity model’ and the ‘natural trading partner hypothesis’ provide theoretical explanations The gravity model, constructed for bilateral trade without a trade agreement, claims that in general, trade between countries is dependent on their

37 EC Council, 1988

38

see Marinello et al., 2015, p 1; Egan, 2010, p 254ff

39

see Freund et al., 2010, p.140

40 see Missios et al., 2016, p 2

41

for details on political and economical motives to join a FTA or CU see for Whalley, 1998 and Woolcock,

2007

geographical closeness and the size of their economies42 With regard to the formation of Free Trade Agreements, Baier and Bergstrand (2004) carried out a study researching what determines the cooperation between countries Their empirical evidence suggests that pairs of countries are inclined to form FTA (1) the smaller the geographical distance between them (as the gravity model suggests), (2) the more they are isolated from rest of the world countries, (3) the larger and more similar the countries are in economic terms (again gravity model), (4) the larger is the difference in capital-labour ratios between countries, and (5) the smaller is the capital-labour ratio difference compared to the capital-labour ratio of rest of the world countries43

The natural trading partner hypothesis had been developed by Wonnacott & Lutz (1989)44 and Krugmann (1991)45 to forecast trade-flows, focussing on regional trade agreements It states that countries are more likely to form Regional Trade Agreements (RTA) when the agreement tends to be trade creating46 and the countries are active in bilateral trade, yet47.The theoretical expectations had been empirically supported by Magee (2003)48

To roughly summarize the first part of theorizing the single market, it can be said that the European countries decided to establish a common market due to geographical closeness as well as already existing trade links (for example within the Benelux countries or between France and Germany) The reason for the continuous expansion from six countries in 1957 to

28 members in 2018 may be further explained through a domino effect49

Besides the formation of a common external tariff in 1968, and further market integration through ECJ rulings as for example in Dassonville50 or Cassis de Dijon51 the EC Commission,

in 1985, however, felt the need to start initiatives to complete the single market Estimates by the Commission as well as the famous 1988 Cecchini-Report ‘on the cost of non Europe’52expected the completion of the single market to be highly beneficial for the European Community, stemming from the removal of trade barriers, economies of scale, consumer surplus and cross-border labor mobility

to seven percent Further, the aggregate cost saving from improved EOS to amount approximately two percent of GDP For the whole EC, the study expected gains of around 4,

25 to 6, 5 percent of GDP from cost savings and price reductions55

Macro-Economic expectations

Beneath gains from exploiting economies of scale, the single market, being analyzed with the economic model of consumer and producer surplus, had also been expected to increase aggregate welfare levels While consumers are estimated to profit from lower price levels in the short run, firms, however, will be able to adapt and eventually benefit only in the medium run56 Accordingly, the Cecchini-Report stated that ‘the first and immediate results will be in terms of downward pressure on prices and costs’57 However, ‘[a]fter about 5 to 6 years, a cumulative impact of + 41/2 % in terms of GDP and -6 % in terms of the price level could be expected’58 In its paper on ‘the growth effects of 1992’, Baldwin (1989)59 emphasizes that the most important effects of completing the single market would not be immediate but rather steady growth effects, eventually even doubling the Cecchini estimates on EC income

While the mobility of the labor force across borders can be expected to be beneficial to the European economy also the workers themselves may profit from their increased flexibility

As for economies of scale, there will be winners and losers This means that increased labor mobility might force workers from high-income countries to face competition leading to a decline in wage levels However, real wages are expected to increase at all skill-levels60 In

the Cecchini-Report, the single market was found to positively affect employment amounting

‘to about 2 million jobs even after absorbing the significant productivity and restructuring effects’61 According to Baldwin62, completing the single market with the 1992 programme would not only rise per capita income but also increase savings and investments in Europe

Even though welfare within the Community as a whole had been expected to rise through the completion of the single market, it has been considered also in the Cecchini-Report that member states may be affected differently with some even suffering from the internal market63 This assumption of different impacts on Community members has been empirically proven by Smith & Wanke (1993)64 However, considering the Heckscher-Ohlin-Samuelson model, in the long term member states were expected to specialize in sectors in which they enjoy a comparative advantage65 On a first assessment, Sapir66, however, did not find a significant degree of specialization in the largest EC countries

b) Single Market effects in practice

As has been shown above, there was huge enthusiasm regarding the completion of the single market due to very positive estimates on economic and welfare effects: Cumulative increases

in GDP of around 41/2 percent in the first five to six years, reductions in price levels of around 6 percent, more than 2 million new jobs throughout the European Community (European Union) and steady growth effects However, some 25 years after the 1992 programme, expectations may be compared with actual developments and real-world data Mariniello et al (2015) provide a good overview on relevant studies on this question and empirical results on a 20+ year period Thus, their paper will be used to view the practical effects of the single market

Looking at different studies suggests that the 1992 programme did indeed have positive effects However, the completion of the single market did not yet provide all the expected benefits Due to different time periods of investigation and varying composition of the European Community or European Union, respectively, the empirical research may not be

directly compared Yet, on an overall assessment, most ex-post studies could not completely confirm the positive ex-ante estimates of Cecchini (1988) and Baldwin (1989)67

For the product market, reducing non-tariff barriers has been trade creating in the beginning and did lead to positive effects on intra-EU exports and imports However, trade integration declined in the first decade of the new millennium Regarding economies of scale, in 1997, there had been found almost no empirical evidence that the ‘substantial unexploited potential economies of scale in European Industry’, claimed by the Checchini-Report68, could have been exploited While competitive behaviour had been found to increase, analysis on firms’ mark-ups provided ambiguous results69 Whereas labour market flexibility remained low until the 2004 eastern-enlargement, capital market liberalization had led to significant impacts on FDI flows in the period between 1985 and 199570 In sum, empirical studies agree that EU GDP would be lower without the 1992 single market programme (SMP) Even though positive, however, real-world single market effects cannot yet catch-up with the advertised economic and welfare effects71

When it comes to reasons for the rather weak single market effect, several still remaining barriers to trade, which negatively impact the performance of the SMP, can be listed First, it has to be mentioned that EU law is not always properly implemented into national law Even though the EU’s transposition deficit improved over the last 20 years, a big problem remains

not whether EU legislation is incorporated into national legislation but rather how Hence,

through intentionally or unintentionally poor transition, trade barriers remain in force Further, barriers to trade exist due to insufficient mutual recognition among the Member States as well

as poor performances in free movement of persons While each citizen enjoys the right to live and work in any of the EU member countries, only 3,9 percent of the EU population (in 2017) actually enjoyed this freedom and did work abroad72

To conclude, starting in 1957, economic cooperation in Europe developed over many decades until the ‘completion’ of the single market in 1993 According to ex-ante evaluations based on economies of scale, consumer surplus and labour mobility in the late 1980’s, the removal of trade barriers was expected to lead to very positive results on productivity, GDP, trade and welfare among the whole European Community or European Union, respectively While some 25 years after its completion the impact of the SMP on the European economy can indeed considered being positive, yet, the advertised effects have not become reality According to a study by the European Parliament an untapped potential in the free movement

of goods of around 1,4 to 2,1 percent of GDP, and 2,6 to 5 percent in GDP through a more deeply integrated market in services could be realised73 The 2010 Monti Report on ‘a new strategy for the internal market’ tackles this ‘bottlenecks’ in detail and provides recommendations to overcome ‘missing links’74 Another important factor may be the rapid dynamics in which market structures are changing (for example current discussions regarding the European Digital Single Market) and the necessary continuous monitoring and adaptation

of legislation Uncovering existing poor transposed legislation as well as observing how changing market dynamics impact the performance of the (digital) single market are interesting fields of further research

3.1 Historical Developments

In its white paper on ‘completing the internal market’, the EC Commission elaborated the concept of one common market and made clear that for political as well as economical reasons, internal frontier controls need to be abolished in their entirety75 While the Commission demanded entry or exit checks for EC citizens coming from or heading to another EC country to be terminated by 1992, several countries, however, started initiatives to end frontier checks already at the time the white paper was drafted76

In 1985, Belgium, the Netherlands and Luxembourg joined an agreement to end border controls which had been started as an intergovernmental initiative between France and Germany Setting out short term and long term measures as well as defining goals and main issues, the agreement signed on 14 June in Schengen (Luxembourg) had become known as the ‘Schengen Agreement’ or ‘Schengen I’77

Five years later, in 1990, the five Schengen countries signed the complementary ‘Schengen Implementing Agreement’ which went into force in 1995 This compact, also known as the

‘Schengen Convention’ or ‘Schengen II’, set out long term measures for the abolition of internal border controls as well as compensatory measures, like for example enhanced controls on borders to third countries or enhanced police and judicial cooperation (also

through the ‘Schengen Information System’)78 On 20 March 1995, borders within the Schengen Area had finally been abolished79

Since the implementation of the Schengen acquis in 1995, most EU member states (except for

Bulgaria, Croatia, Cyprus, Romania, Ireland and the UK) as well as several non-EU member states (Iceland, Norway, Liechtenstein and Switzerland) are now part of the Schengen-Area80 During the years, the Schengen Convention had been subject to several changes due to institutional reforms (for example abolishing the pillar-structure of the Maastricht-Treaty) but

also due to further development of the Schengen acquis, for example through the Schengen

Borders Code in 2006 (replaced by Regulation 2016/399)81

3.2 The Schengen Agreement: A legal perspective

Signed by only five countries in the beginning, Schengen I and II started as intergovernmental agreements Soon, however, the Schengen Area expanded to include almost every EU country, eventually leading to the integration of the Schengen provisions into the legal framework of the Union, in 199782 The ‘Protocol integrating the Schengen acquis into the framework of the

European Union’83 had been attached to the then signed Treaty of Amsterdam, making the Schengen provisions part of the EU legal and institutional framework84 New Member States

joining the European Union are now bound also to the Schengen acquis, once meeting certain

requirements85

Today, the relevant provisions can be found in art 67 to 89 within the fifth title of the TFEU which regards the ‘area of freedom, security and justice’ While chapters 1 and 2 deal with general provisions and policies on border checks, asylum and immigration, chapters 3 to 5 specify judicial cooperation in civil and criminal matters, and police cooperation These chapters stem from the original Schengen Agreement and the request to set up measures compensating the lack of border controls For the aim of this thesis, however, solely provisions related to border checks (chapter 1 and 2) and in particular, the removal of checks

on persons will become relevant

As part of the first chapter on general provisions, Art 67(2) states that

‘[The Union] shall ensure the absence of internal border controls for persons and shall frame a common policy on asylum, immigration and external border control, based on solidarity between Member States ’

Similarly, art 77(1)(a) requires the Union to develop a policy

‘ensuring the absence of any controls on persons, whatever their nationality, when crossing internal borders ’

These provisions are quite similar with original key rules concerning free movement within the Schengen area, contained in the 1990 Convention implementing the 1985 Schengen Agreement, for example:

‘Internal borders may be crossed at any point without any checks on persons being carried out ’ 86

or,

‘The Contracting Parties shall jointly ensure that their laws, regulations or administrative provisions do not unjustifiably impede the movement of goods at internal borders ’’ 87

In order to ensure the absence of controls on persons as well as an efficient monitoring of the crossing of external borders and the gradual introduction of an integrated management system for external borders (see for art 77(1)), art 77(2) requests the European Parliament and the Council to adopt measures concerning

‘a) the common policy on visas and other short-stay residence permits;

b) the checks to which persons crossing external borders are subject;

c) the conditions under which nationals of third countries shall have the freedom

to travel within the Union for a short period;

d) any measure necessary for the gradual establishment of any integrated management system for external borders;

e) the absence of any controls on persons, whatever their nationality, when

crossing internal borders.’

Since the provisions in title V do not provide for restrictions to the non-existence of border controls, in accordance with art 77(2) (back than art 62), Regulation 562/200688, also known

as ‘Schengen Borders Code’ had been adopted, providing for detailed rules regarding internal and external border control as well as the temporary reintroduction of controls at internal borders In 2016, also in accordance with art 77(2), this Regulation 562/2006 has been repealed and replaced by Regulation 2016/39989 on a Union code on the rules governing the movement of persons across borders (however, still named ‘Schengen Borders Code’) According to art 25 to 35 of Regulation 2016/399, internal border controls may be reintroduced under certain circumstances, following specific procedures (for detailed information on the reintroduction criteria and procedure see the relevant articles) In brief, border controls can be reintroduced, as a measure of last resort, for a duration of maximum 30 days (may be expanded) in case that there is a serious threat to public policy or internal security in a Member State

Today, more than 400 million citizens of 26 countries can travel within the Schengen Area needing nothing but to hold a valid identity card90 Hence, it can be said that the Schengen initiative, starting in 1985, clearly succeeded in removing controls on internal borders and enhanced free movement among Europe

Neither within the original Schengen Convention nor, since its implementation into EU law, within the Treaties or the Schengen Borders Code, Schengen has an explicit task regarding facilitation of trade within the Union However, since both the Commission’s 1985 initiative for the 1992 programme as well as the SEA view the removal of internal borders as a necessary step to integrate the market, Schengen has been viewed as having positive effects

on trade within the Union, facilitating to obtain the requested completion of the single market Hence, in the following, Schengen-effects on intra European trade shall be examined and put into relation with the single markets’ positive effects on trade

3.3 Schengen effects on intra European trade

As has been shortly introduced in theorizing the single market, the gravity model in its simplest form suggests that countries, which are close to each other in terms of geographical distance and size, are more likely to trade with each other The basic gravity model specification therefore may be shown as91:

88

European Parliament & Council, 2006

89 European Parliament & Council, 2016

where NetTradeijt denotes country i’s net trade totals with country j in year t; GDPit and GDPjt

are the total national incomes of countries i and j, respectively, in year t; and Distanceij is the distance between the countries’ capital cities

But even if countries do fulfil the gravity models’ requirements of small geographical distance and equal size, borders might still be an obstacle to trade and may hamper trade flows between two countries Considering trade between Canada and the US, McCallum (1995)92 has shown that even though size and distance were equal, Canadian provinces traded

on average 20 times more with other Canadian provinces than with US states Anderson and Van Wincoop (2003)93 support McCallum’s results Further, estimating a theoretical gravity equation they draw some general conclusions on cross country trade barriers: (1) Due to border barriers trade between large countries drops more than trade between small countries, (2) cross country trade barriers raise trade within a country more for small than for large countries and (3) even a small drop in international trade can lead to a very large increase in trade within a small country

Head and Mayer (2002)94 found that while border effects are illusory due to miscalculation and may be less than estimated, they do, however, exist and have a certain impact on trade patterns Further, they came to the conclusion that even after the completion of the 1992 programme in 1993, borders across the Union did not become irrelevant but had significant effects on intra-EU trade Supporting, Chen (2004)95 finds that a EU country trades about 6.5 times more with itself than with other EU members

According to Möhlman et al (2009)96 border effects can be divided into tangible and intangible barriers, both having negative impacts on cross-border trade developments Tariffs and quotas as well as costs for transport and administrative burdens can be considered to be tangible barriers Intangible barriers include culture, language, institutional set-up and colonial history Incorporating the distance of intangible barrier variables into the basic gravity model specification shown above, the equation may be adapted as to97:

Where Tij stands for exports from country i to country j; K is a scalar; Yij and yij represent the products of GDP and GDP per capita of country i and j; and Dij, CDij and IDij reflect physical, cultural and institutional distance between the countries The matrix Mij contains additional variables that may affect the ease of trading bilaterally, such as a common border, linguistic

or colonial links and common trade bloc membership

Through the 1990 Convention Schengen has been established to support the idea of a unified Europe and the creation of an area ‘without internal frontiers’ (now Art 3(2) TEU) In the following, through comparing the scarce currently existing empirical literature on Schengen effects, it shall be examined whether undoing border controls has positive effects on trade within the European Union Further, the first research question asking

Q1: ‘Is the Schengen Agreement as part of the European Single Market legit from an economic perspective regarding its additional benefits to intra-EU trade? ’

will be answered accordingly

The Schengen acquis provides for the abolition of border controls and thus makes borders

within the EU less relevant However, looking at the above presented tangible and intangible barriers it becomes obvious that, except costs for transport and administrative burdens, none

of these border barriers is affected by the Schengen Agreement This raises the question how, under these circumstances, Schengen should add benefits to cross-border trade and leads to the assumption that

H1: The Schengen Agreements ’ liberalizing effect on border controls within the European Union does not provide any remarkable additional benefits to the EU single markets ’ positive effects on intra- EU trade in goods

Chen and Novy (2011)98 show that Schengen has helped to foster trade integration through the elimination of administrative burdens and time delays Further, that trade frictions between two participating countries decrease by 10 percent compared to non-participating countries These findings are supported by an earlier study of Francois et al (2003), observing trade between USA and Mexico, stating that removing border impediments on trade and border crossing frictions can lead to still greater efficiencies and welfare99

Davis and Gift (2014)100 studied trade effects of Schengen and found positive results mainly due to migration flows According to their research migrants are expected to bring preferences

98 Chen & Novy, 2011

into the host country, thus impacting imports and exports A net increase in immigrants by 1 percent is assumed to increase trade by an almost equivalent amount Parsons (2005)101supports this result, finding that an increase in immigrants by 1 percent leads to a 0,12 percent increase in host countries’ exports and a 0,14 percent increase in host countries’ imports102 Further, Davis and Gift103 found that trade between two Schengen countries increases by 0, 10 percent a year

These positive effects however, need to be set into relation with actual migration flows Following the European Commissions’ 2017 annual report on intra-EU labour mobility104, only 3,9 percent of the total working age population in the EU 28 make use of their right to work abroad The same holds true for cross-border workers While Ademmer et al (2015)105claim undertakings in border regions and commuters in particular, to benefit most from the absence of border controls, this group of Schengen beneficiaries, however, represents merely 0,6 percent of the total EU 28 working age population106 According to Bartz and Fuchs-Schündeln (2012) 107 language barriers are the key reason for poor labour mobility performance and small labour market integration across countries They come to the result that abolishing border controls through the Schengen Agreement did not lead to a significant increase in cross-border correlations of unemployment rates and hence, intra-EU migration Indeed, Davis and Gift (2014)108 find small positive Schengen effects on trade stemming from intra-EU migration However, as has been shown above, numbers of intra-EU migration are exceedingly small compared to total EU population Hence, positive Schengen effects on trade stemming from migration may be rather diminishing

Felbermayer et al (2018)109 search the trade effects of border controls in a Schengen context While they are emphasizing the need to consider the spatial structure of Schengen and the fact that the total pair-level effect increases the more borders get crossed by trade partners, it needs to be mentioned that this effect is, like the immigration effect, self-relativizing Less than three percent of trade within the European Union crosses more than three borders110 Hence, even though the total pair-level effect increases with the borders to be passed, the number of cases in which this will be relevant is only little

101 Parsons, 2005

102

see Parsons, 2005, p 27; Davis & Gift, 2014, p 1543

103 Davis & Gift, 2014

104 see European Commission, 2018, p 22

105 see Ademmer et al., 2015, p.3

106

see European Commission, 2018, p 22

107

Bartz and Fuch-Schündeln, 2012

108 Davis and Gift, 2014

Nevertheless, Felbermayer et al (2018) do not view the Schengen Agreement as an important measure regarding EU trade integration While they do find a total average trade creating

effect of around 2,81 percent which constitutes an ad valorem tariff equivalent (AVTE) of

0,46 percent, however, they conclude that in comparison with other measures of EU integration the Schengen effect on trade is comparably low The European Customs Union, for example, increased trade in goods by 53,2 percent; the Single Market by 69,4 percent

Taking into account the results of existing empirical literature on Schengen effects on trade, it can be drawn the conclusion that the assumption,

H1: ‘The Schengen Agreements’ liberalizing effect on border controls within the

European Union does not provide any remarkable additional benefits to the EU single markets ’ positive effects on intra-EU trade in goods.’,

can be verified Even though scarce positive effects on intra-EU trade in goods have been found, the overall results are not sufficient enough to reject the hypothesis Schengen provides

no remarkable additional benefits to intra-EU trade in goods This is the main finding so far Due to the multifaceted nature of Schengen and its various impacts on cross-border flows, more research is necessary to draw clear and unambiguous conclusions on trade effects More research would be needed regarding countries’ different levels of integration into the system

of the European Union While some are part of EMU and Schengen, others participate solely

in either EMU or Schengen or are not even an EU member country111 A further interesting field of research would be how tourism affects trade across countries and which role Schengen plays in this relation The up-coming accessions of Bulgaria and Romania into the

Schengen acquis provide the chance to compare ex-ante and ex-post studies on trade effects

and might potentially allow gaining new insights

Yet, what does the outcome on the first hypothesis imply for the research question on legitimacy? Concerning additional benefits to the single market’s positive effects on trade, the Schengen Agreement does not provide any remarkable benefits Taking into account the loss

of sovereignty for national states when giving up control over national borders as well as high efforts and expenses for compensatory European-level cooperation on police and judicial matters, the legitimacy of Schengen based on economic reasons can be doubted Hence, the first research question asking

Q1: ‘Is the Schengen Agreement as part of the European Single Market legit from an economic perspective regarding its additional benefits to intra-EU trade? ’

111

ibid

can be answered in the negative But even though the question whether Schengen is legit regarding its additional benefits to positive single market effects on trade has to be answered

in the negative, the Schengen Agreements’ political value should not be neglected

3.4 Current Challenges of Schengen: The 2015 Refugee Crisis

In 2015, Europe arrived at the peak of the biggest migration crisis since World-War II Around 1.3 million refugees entered the European Union at this time; and as different as the migrants were regarding their nationality or reasons to flee, as different had been the reactions

of European Member States to deal with the influx Soon the migration crisis developed also

to a solidarity crisis putting pressure onto Schengen and free movement provisions

All started with the so called Arab spring uprisings in North African countries, which first began in 2010 with the Tunisian Revolution and virtually immediately spread to neighbouring countries such as Libya, Syria, Egypt, Yemen and Bahrain There, the rise in new national awareness for democracy and the rule of law as well as the increasing dissatisfaction with the political or military regimes resulted in mass demonstrations against the current regimes These prior peaceful events soon deteriorated to various violent clashes and finally major civil wars that still shake these countries112 Due to the hazardous situations in their home countries and in search for protection from political or military prosecution and dangers, many citizens were forced to leave their homes and thus the process of mass migration to European countries began This mass migration flow from North African and Middle Eastern countries together with economically motivated migration inflows113 to the European Union should then later be called the ‘refugee crisis’

In 2013, approximately 100.000 refugees more than in 2012 had been recorded, which stands out compared to the rather stable numbers in prior years114 Hence, 2013 can be considered to

be the first year in which the consequences of the Arab Spring could be directly felt in Europe The amendment of the above mentioned Schengen Borders Code through Regulation 1051/2013115, providing for common rules on the temporary reintroduction of border controls

at internal borders in exceptional circumstances, and Regulation 610/2013116 (Schengen Governance Package), proves 2013 to be the year in which the need for action on Union level had been recognized

112

see Hollis, R., 2012 and Anderson, L., 2011

113

see for Popa, 2016, p 97f

114 see European Parliament, 2018

From 2013 onwards, refugee numbers arriving in Europe increased dramatically, reaching its peak in 2015 with some 1,321,600 refugees registered117 In the following two years however, the influx declined reaching its lowest level at around 150.000 in 2017118 Unfortunately, the reason for the stop of the migration influx is not the end of (civil-) wars in the countries of origin, but measures and agreements that have been adopted by the European Union as a whole or individually by its member states119

In general, the refugee crisis affects two fields of the Schengen provisions First, the migrant crisis is an issue of securing the external border as well as setting up measures and regulations

to manage migrant movements into Europe, as for example through the well-known Dublin

Regulations Since the paper on hand, however, focuses on the occasions within the Schengen

Area, issues concerning external border security or allocation measures will not be covered Second, the migrant crisis is an issue of solidarity and mutual trust among the EU member states Concerning this second aspect, methods of how to deal with the refugee influx differed enormously among the Member States from partialist to impartialist approaches120

While in many countries a so called ‘welcoming culture’ developed121, others, like Hungary

or the Czech Republic were strictly against giving asylum to refugees122 Especially the frontline countries (Member States having a border to non-Schengen countries) had been highly affected by refugee inflows and missing allocation and called for a European solution Due to uncertainty on whether a pan-European solution will be found, some frontline countries allowed refugees to transit through their countries, heading to Austria, Germany, Denmark or Sweden123 As a reaction, Austria re-established controls at internal south-borders which soon had been adapted also by Belgium, Denmark, France, Germany, Norway, Sweden and Hungary, applying article 25 of the Schengen Borders Code124 Article 25 of the Schengen Borders Code states that:

“Where, in the area without internal border control, there is a serious threat to public policy or internal security in a Member State, that Member State may exceptionally reintroduce border control at all or specific parts of its internal borders for a limited

117 see European Parliament, 2018

118 see Human Rights Watch, 2017

119 for details on measures and agreements see Popa, 2016, p 99ff

120

see Stern, R.T., 2016; Greenhill, K M., 2016

121

see Thielemann, E., 2018

122 see The Guardian,2015; Reuters, 2015

period of up to 30 days or for the foreseeable duration of the serious threat if its duration exceeds 30 days [ ] ”

Although, article 25 provides for only a ‘limited period’ of border controls, the duration of checks had been extended until now The question whether the introduction of border controls may be justified can be answered in the affirmative Even though recital 26 of the Codification of the Schengen Borders Code125 expressis verbis states that,

“Migration and the crossing of borders by a large number of third country-nationals should not, per se, be considered to be a threat to public policy or internal security ”,

according to recital 25, however, border checks may be introduced due to terrorism

“The reintroduction of internal border control might exceptionally be necessary in the case of a serious threat to public policy or to internal security at the level of the area without internal border control or at national level, in particular following terrorist incidents or threats, or because of threats posed by organised crime ”

Since it has been expected (and in the case of terrorist attacks in France has been proved right) that terrorists may abuse the migrant flows to enter the Schengen Area, from a legal perspective the reintroduction of border controls can be considered as justified126

Today, six countries (France, Austria, Germany, Denmark, Sweden and Norway) execute border controls under article 25 of the Schengen Borders Code, at least until November

2018127

Due to the repeating extensions of controls on internal borders it has been highly discussed whether it would make sense to temporarily suspend Schengen or even permanently reintroduce border checks and as a consequence abolish the Schengen provisions128

Even though, as has been shown above, Schengen does not provide any additional benefits to the single markets’ positive effects on intra-EU trade, several studies find that abolishing Schengen would have negative effects on trade within the Union and warn to do so Hence, the following chapter now focuses on potential economic effects that may be expected if the Schengen provisions on the removal of border controls would be abolished

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European Parliament & Council, 2016

126 see Popa, 2016, p 98; Hummer, 2016, p 9f

Even if the Schengen provisions are under enormous pressure and get attacked by some member states for quite a long time, the European Commission is a strong proponent for the Agreement, advocating its economical and political benefits But although there is a huge discussion on whether Schengen shall be abolished, the amount of available empirical literature on which such a debate can be based upon is rather small

Nevertheless, in the following, concerning the few existing studies on non-Schengen scenarios, costs to be expected without the Schengen provisions will be presented Thereafter the empirical part of the thesis on hand will be introduced, elucidating the methodology being used as well as the data that had been collected and used for the analysis Having presented the results of the survey, they get put into discussion with the findings of the empirical research indicated below, answering the second research question which asks:

Q2: ‘What potential impacts could an abolition of the Schengen Agreement have on trade in goods amongst members of the European Union considering effects on the Austrian transport sector? ’

In a briefing for the European Parliament on Schengen and effects on reintroducing border controls129 and a further communication on non-Schengen130 the EPRS (European Parliament Research Service) presents costs to be expected once the Schengen Area would no longer exist as it does in its current form Listed in four sub categories, an increase in costs is expected for (1) cross-border transport of goods, (2) commuters, (3) tourism and (4) the

public sector The numbers used are taken from ex-ante evaluations on non-Schengen by the

Bertelsmann Stiftung (2016)131and Aussiloux & Le Hir (2016)132 Those two studies can be seen as the guiding papers on which all other evaluations do rely on133

According to the EPRS, due to an increase in waiting times, costs for road transport could

increase by € 1.7 € to € 7.5 billion per year But also the manufacturing industry may be hampered by increases in transport costs of some 5 percent Furthermore, abolishing Schengen would be equivalent to a 3 percent VAT, potentially leading to a decrease in trade flows within the Schengen Area by 2,5 percent within the next seven years134 For commuters,

129 see for EPRS, 2016b

130 see for EPRS, 2016a

131

Bertelsmann Stiftung, 2016

132

Aussiloux & Le Hir, 2016

133 e.g see Wirtschaftskammer Österreich, 20f18; European Council on Foreign Relations, 2018; Felbermayer et al., 2016; Felbermayer et al., 2018; & Deringer, 2016

134

see EPRS, 2016b, p 4; EPRS, 2016a, p 2; & Aussilloux & Le Hir, 2016, p 12