Understanding the European Union: Its Purpose, Historical Roots, and Membership

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The European Union (EU) is a political and economic union of 27 European countries that pool part of their sovereignty to set common rules on trade, competition, agriculture, consumer protection and many other policy areas. Unlike a simple free trade agreement, the EU has its own institutions, its own law that overrides conflicting national law in areas members have handed over, and a shared budget. A subset of members also share a currency, the euro.

What the European Union is

The EU sits between a trade bloc and a federal state. Members keep their own governments, armies, tax systems and seats at the United Nations. In return for access to a large common market, they accept shared rules written and enforced at the EU level.

The EU’s purpose is twofold. Economically, it removes barriers so firms and workers can operate across 27 countries as if in one market. Politically, it binds former rivals together so that war between them becomes unthinkable, and it promotes democracy, the rule of law and human rights among members. Applicants must meet political and economic conditions before they are admitted.

How the EU works

Institutions

Power is divided among several bodies:

• European Commission: proposes legislation, enforces EU law and negotiates trade deals on behalf of all members.
• European Parliament: directly elected by citizens since 1979; it amends and approves laws and the budget.
• Council of the European Union: national government ministers who adopt laws together with Parliament.
• European Council: heads of state or government who set overall political direction.
• Court of Justice of the European Union: interprets EU law and settles disputes over it.
• European Central Bank (ECB): sets monetary policy for the countries that use the euro.

The single market and customs union

The single market rests on the “four freedoms”: goods, services, people and capital move across internal borders without tariffs, quotas or most border checks. Common product standards mean a product approved in one member state can generally be sold in all of them.

The customs union means members charge no duties on trade with each other and apply a single tariff to goods from outside. Trade policy is therefore handled by the EU as a bloc, not by individual capitals.

Who pays for it

The budget is funded mainly by member contributions based on each country’s gross national income, a share of value-added tax revenue and customs duties collected on imports into the union. Wealthier members typically pay in more than they receive, while poorer regions receive development and agricultural funds.

Origins and growth

From coal and steel to a single market

The founding members were Belgium, France, West Germany, Italy, Luxembourg and the Netherlands. In 1950 they agreed to place coal and steel production, the raw materials of war, under common management, creating the European Coal and Steel Community.

In 1957 the Treaty of Rome created the European Economic Community (EEC), later known as the European Community (EC). Its early work centered on a common agricultural policy and dismantling customs barriers among members. Denmark, Ireland and the U.K. joined in 1973, the first enlargement, and direct elections to the European Parliament began in 1979.

The Single European Act of 1986 launched a program to harmonize national regulations and complete the single market. The Maastricht Treaty, in force from 1993, created the European Union in its current form, extended cooperation into foreign policy, security and justice, and laid out the path to a common currency. The EU as such therefore dates from 1993, although its institutions date back to the 1950s.

Enlargement to the east

After the collapse of the Soviet bloc, the EU expanded east. Ten countries joined in 2004, including Poland, Hungary and the Czech Republic, followed by Bulgaria and Romania in 2007 and Croatia in 2013.

The euro and the eurozone

The euro launched on January 1, 1999, as an accounting currency, with notes and coins entering circulation in 2002. Countries that use it form the eurozone, and their monetary policy is set by the ECB.

To join, a country must meet convergence criteria set out at Maastricht, including a government deficit below 3% of GDP and public debt below 60% of GDP (or falling toward it), along with limits on inflation and interest rates. Denmark and the U.K. negotiated formal opt-outs. Other members have not yet met the criteria or have chosen to wait. Croatia became the 20th country to adopt the euro in 2023.

Example: what membership changes for a business

In a hypothetical example, a furniture maker in Portugal sells to customers in Germany. Because both countries are in the single market and customs union, the shipment crosses the border without duties or customs declarations. Because both use the euro, the seller faces no exchange rate risk on the invoice.

A rival in a non-EU country ships the same furniture to Germany. It pays the EU’s common external tariff, and that tariff is the same whether the goods land in Lisbon, Rotterdam or Hamburg. It must also meet EU product standards and absorb currency swings between its home currency and the euro.

The shared currency cuts both ways. Suppose Portuguese labor costs rise faster than German ones. A country with its own currency could let it depreciate, say by 10%, making its exports about 10% cheaper abroad overnight. Inside the eurozone that option does not exist, so Portugal would have to regain competitiveness through lower wage growth, higher productivity or both, which is slower and more painful.

The debt crisis and new safeguards

That trade-off became visible after the 2007 to 2008 global financial crisis. Greece, Ireland, Portugal, Spain and Italy faced high sovereign debt and weak growth. Greece and Ireland received EU bailouts in 2010 on condition of fiscal austerity, Portugal followed in 2011, and Greece needed a second package in 2012.

The EU responded by building permanent crisis tools:

• The temporary European Financial Stability Facility (2010) was replaced in October 2012 by the European Stability Mechanism (ESM), which lends to members in severe financial trouble, including those shut out of bond markets.
• The ECB offered banks favorable financing through targeted longer-term refinancing operations in 2014, 2016 and 2019.
• 2015 guidance added flexibility to the Stability and Growth Pact, which enforces the 3% deficit and 60% debt reference values.
• The Single Resolution Board, set up in 2015, winds down failing banks in the euro area.

Limitations

The crisis measures stabilized markets but did not remove a deeper imbalance: the gap in wealth and productivity growth between the industrialized north and a southern periphery that is less urbanized and more reliant on agriculture.

The United States eases regional gaps partly through federal transfers. Higher-income states contribute a larger share of federal revenue, and lower-income states receive a larger share of federal spending. The EU budget is small relative to its members’ economies and taxation remains national, so it has no equivalent fiscal union. Joint recovery borrowing during the COVID-19 pandemic was a step in that direction, though critics call it incomplete and fragile.

Decision-making is another constraint. Some areas, such as foreign policy and taxation, require unanimity, which lets a single member block action.

Brexit

Under pressure from the anti-EU U.K. Independence Party, Prime Minister David Cameron promised a referendum in 2013 and held it on June 23, 2016. Leave won with nearly 52% of the vote, and Cameron resigned the next day. After years of negotiation under Article 50 of the Treaty on European Union, the exit clause, the U.K. formally left on January 31, 2020, the first member state to do so, reducing membership from 28 to 27.

EU, eurozone, Schengen and Europe: common confusions

• EU vs. Europe: Europe is a continent of roughly 45 to 50 countries. Norway, Switzerland, Serbia and the U.K., among others, are European but not EU members.
• EU vs. eurozone: the eurozone is the group of EU members using the euro. A country can be in the EU without using the euro, and a few non-members such as Montenegro use it without being in the EU.
• EU vs. Schengen Area: Schengen abolishes passport checks at internal borders. It includes non-EU countries such as Norway, Iceland and Switzerland and excludes Ireland.
• EU vs. European Economic Area (EEA): the EEA extends the single market to Norway, Iceland and Liechtenstein, which follow most single-market rules without voting on them.
• EU vs. Council of Europe: the Council of Europe is a separate human rights organization with more members, unrelated to the EU’s Council bodies.
• EU vs. other blocs: groupings such as BRICS coordinate policy among sovereign economies but have no shared law, single market or common currency.

The Bottom Line

The EU shapes costs and risks for any business trading in Europe, since members trade duty free while outsiders pay a common external tariff and meet EU product standards. The euro removes exchange rate risk between users but takes away currency devaluation as a tool, leaving weaker economies to adjust through wages and productivity. Without a fiscal union, gaps between the richer north and the southern periphery remain.