Departure from Schengen Agreement

CLICK HERE TO READ THE NEW GED STUDY: DEPARTURE FROM THE SCHENGEN AGREEMENT

In July 2014, we demonstrated how the creation of the European single market and associated increasing economic integration has a positive effect on growth for all countries concerned. The reintroduction of border controls currently under discussion would be a backward step for European integration. In this post, we show how large the economic losses for Europe could be if the Schengen Agreement were to be permanently abolished.

The Schengen Agreement – what is it all about?

The removal of border controls at internal borders of the European Union (EU) began with the Schengen Agreement, signed in 1985. The agreement came into force in 1995. The first countries to abolish checking persons at their borders were Belgium, France, Germany, Luxembourg, the Netherlands, Portugal and Spain. Today, 26 countries belong to the Schengen area and 22 of these are members of the EU.

What economic costs are associated with the reintroduction of border controls?

The control of persons at the border also applies to the cross-border movement of goods. What is merely an annoying waste of time for individuals translates into higher costs for companies, where long waiting times at borders result in higher personnel costs for the company. In addition, larger inventories are needed, because a just-in-time delivery can no longer be guaranteed. This increases storage costs for the company. Higher production costs then also lead to higher prices for manufactured goods.

Higher import prices cause a general price increase in national economies and this increase reduces consumer purchasing power and consequently reduces consumer demand. Furthermore, a price increase also normally leads to a subsequent increase in wage and salary demands. Increasing wages result in increased labour costs or, more accurately, increased unit labour costs for companies. As a result, the international competitiveness of domestic companies falls and the result is lower exports.

If consumer demand as well as exports decline, there is less of an incentive to invest. Investments increase production capacities, but in case of lower demand from consumers and foreign countries, this increase is not necessary.

All in all, price increases for imported goods caused by border controls lead to a general price increase and a decline in consumer demand, exports and investment. Provided that companies adapt to the diminishing sales opportunities, domestic production will decrease. This further results in lower gross domestic product (GDP), i.e. the value of all goods and services produced within one year in a country. The economy therefore grows more slowly and, at the same time, a smaller workforce is needed, so unemployment rates increase.

How high is import price inflation?

The exact extent of the price increase depends on many factors that cannot be predicted with any certainty. It is especially unclear how stringent the border controls may be and how many inspectors would be involved. The latter point is particularly decisive for waiting times at the borders. Based on the findings of other studies that have determined the level of costs arising as a result of intra-European border controls, we have relied on two assumptions in the following scenario calculations.

• Conservative assumption (scenario 1): here, we assume moderate import price inflation in the amount of one percent.
• Pessimistic assumption (scenario 2): in this scenario, we assume that the border controls lead to a three percent price increase in cross-border trade in the Schengen area.

Based on these two assumptions, and using a macroeconomic model that encompasses 42 countries, we have calculated how the GDP will have developed in these countries by 2025. This economic development is compared with a baseline forecast in which the Schengen Agreement is still in place.

Which countries and how much do they lose?

In all the countries examined, the permanent reintroduction of border controls results in smaller GDP growth. With a rise in import prices of only one percent, German GDP, for example, would grow in the period between 2016 and 2025 at an annual rate that would be 0.03 percentage points lower than if border controls were not introduced. The associated reduction in growth over the ten years (2016-2025) would total approximately €77 billion. For France, the calculations lead to a cumulative loss of growth to the amount of €80.5 billion (see Figure 1, light blue data bar). For the EU-24 (the countries of Luxembourg, Malta, Cyprus and Croatia are not included in the macro model due to data gaps) the loss of GDP in the space of ten years would total approximately €470 billion.

Due to increasing international interconnections, there are also countries that will be affected by growth dampening effects, but are not European. In China and the United States, the rate of growth between 2016 and 2025 would be lower year-on-year by an average 0.01 percentage points. Because these two countries are the world’s largest economies, growth losses may reach the amount of €91 billion for the United States by 2025, and €95 billion for China.

In the case of a greater rise in import prices, the loss of growth could be larger. A cumulative loss of GDP of almost €235 billion is calculated for Germany. The loss of growth in France would amount to €244 billion over the 10 years (see Figure 1, dark blue data bar). Finally, cumulative GDP losses of €1.4 trillion are calculated for the EU 24.

What other economic disadvantages have to be taken into account?

The calculated loss of growth does not take into account all of the long-term economic consequences that would be associated with a permanent reinstatement of border controls. Of the numerous additional consequences, only three can be mentioned in brief here:

• For commuters who live in Germany and work in the Netherlands, for example, border controls would result in longer travelling times. Even if it is unlikely in the short term that anybody would leave their job abroad, border controls make working in another country complicated. In the medium term, this may restrict cross-border job mobility.
• Tourism is an industry that would especially suffer under the termination of the Schengen Agreement. Declining numbers of day trips and short breaks at least would be feared. This would predominantly concern the border regions, where it would result in a loss of revenue and jobs.
• European companies obtain many preliminaries from suppliers in other European countries. This integration into global value chains  reduces production costs and increases competitiveness. A rise in the cost of preliminaries from abroad would mean that some forms of this international division of labour would no longer make financial sense. This also has a knock-on effect on the competitiveness of companies in Europe.

Conclusion

Border-free travel in the Schengen Area is one of the great achievements of European integration. A departure from the Schengen Agreement would have significant economic disadvantages on a global scale. The simulation calculations we have presented here show that significant growth losses should be feared, even with only a one percent increase in prices for goods traded between Schengen members. Even in the best case assumed here, Europe-wide growth losses would total approximately €470 billion by 2025. In addition to this, there are further economic disadvantages (such as those for commuters, the tourism industry and international value chains), and these losses have not yet been taken into account at all. Finally, it should also be borne in mind that the abolition of borders, in addition to the Monetary Union, is probably perceived by citizens as one of the biggest advantages of an increasingly unified Europe. Taking into account the economic and socio-political consequences that would be the result of a reintroduction of border controls, this step should be avoided if at all possible.

Note for the reader: A more detailed description of the economic consequences of a move away from the Schengen Agreement can be found in our new GED study “Departure from the Schengen Agreement”