Baldwin

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The Economics of European Integration
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Chapters 6-7Deepening of economic integration
in the EU and dynamic effectsKatja Zajc
Kejarpresentation in part adapted from
BaldwinWplosz 2006
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Dynamic effects of economic integration

• In previous lecture we focused on static effects.
  
• However, the deeper and wider the economic
  integration the more diverse and intensive are
  its effects, especially dynamic.
• Market size effect
• Scale effect
• Competition effect
• Growth effects
• induced investment rate rise
• Faster and more intensive international
  technology transfer and dissemination due to
  easier cooperation and integration of firms from
  different MS
• Labour market effects

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Progressive stages in EU economic integration
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Rome Treatys objectives

• Main goals of the EU as set in Article 2 of
  Treaty of Rome (1957/58)
• "The Community shall have as its task, by
  establishing a common market and progressively
  approximating the economic policies of MS, to
  promote throughout the community a harmonious
  development of economic activities, a continuous
  and balanced expansion, an increase in stability,
  an accelerated raising of the standard of living
  and closer relations between the MS belonging to
  it".

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EU went through different integration stages

• 1968 - customs union is established
• removing all tariffs on intra-EC trade and
  adopting a common external tariff
• 1.1.1993 - Internal market introduced
• 1985 White Paper starting the preparation for
  introduction of Internal market
• 1986/1987 Single European Act provided for
  the adaptations required for introduction of the
  Internal Market
• 1.1.1999 - Economic and Monetary Union (EMU)
  started to work for initial 11 members fulfilling
  the 5 nominal (Maastricht) convergence criteria.
• Treaty on European Union, signed in Maastricht
  (1992/1993)
• Towards the political union - ?

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Milestones
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Internal market regime
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Free trade of goods

• The Single Market Programme ? abolition of the
  following types of barriers in goods markets
• Physical frontiers
• elimination of border formalities
• Technical standards
• Harmonisation and mutual recognition of technical
  standards in production, packaging and marketing
• Fiscal differences
• Government reluctant to forego the right to alter
  rates
• Slow progress in harmonisation of VAT rates
• Minimum standard rate of 15 with reduced rates
  of 5 agreed, but no agreement on Commission
  proposal to set a maximum of 25

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Free movement of services

• Services trade integration has been slower and
  more difficult than product market integration
• Services trade not restricted by tariffs but by
  domestic regulatory regimes
• EU Treaties distinguish between
• Establishment - the professional has an
  infrastructure in the host member state either
  he wants to transfer his main establishment in
  the host member state or he wants to have a
  secondary establishment.
• Cross-border provision of services - services are
  provided on a temporary and occasional basis
  (assessed in relation to duration, frequency,
  regularity and continuity of services).

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Free movement of capital

• from 1 July 1990 full liberalisation of capital
  movements between MC
• Capital movements include direct investments,
  investments in real estate, operations in
  securities and in current and deposit accounts,
  and financial loans and credits.
• "safeguard clause protective measures to ensure
  liquidity of local banks and temporary
  restrictions in case of major disruptions in
  foreign exchange markets
• shall not exceed six months period.

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Free movement of worker

• A worker on the territory of another MS is
  entitled to the same priority as the nationals of
  that MS as regards access to available employment
  and to the same assistance
• Non-discriminatory principle recruitment may not
  be dependent on medical, occupational or other
  criteria which discriminate on the grounds of
  nationality.
• Prohibition of any-discrimination based on
  nationality as regards
• working and employment conditions
• entitlement to occupational training and
  retraining measures.
• social and tax advantages
• equal treatment in respect of the exercise of
  trade union rights
• Need for recognition of professional
  qualifications.

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Assessing the dynamic effects in the EU
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Pre-integration market fragmentation

• Various barriers (physical, technical, fiscal) to
  intra-EU trade before internal market introduced
• ? market fragmentation
• ? reduces competition, raises prices, too many
  (inefficient) firms in business

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1. Market size scale effects and industrial
restructuring

• liberalisation removal of physical, technical
  and fiscal barriers?
• de-fragmentation ?
• pro-competitive effect (competition intensifies)
  ?
• industrial restructuring (MA, etc.)
• RESULT fewer, bigger, more efficient firms
  facing more effective competition from each
  other, prices fall, output rises.

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Economic Logic

• Integration of two symmetrical markets
  no-trade-to-free-trade.
• De-fragmentation
• PRE typical firm has 100 sales at home, 0
  abroad POST 50-50 ,
• Pro-competitive effect (before the number of
  firms can adjust)
• Immediate impact each firm is provided with a
  second market of the same size, the number of
  competitors is doubled in each market. Firms
  losing money.
• Pro-competitive effect mark-up falls.
• short-run price impact p?.
• Industrial Restructuring and scale effects
• The profit looses trigger the process of
  industrial restructuring
• number of firms?,
• Price slightly rises, but not to the
  pre-integration level
• Surviving firms enlarge market shares and output
• More efficient firms, AC falls (increasing
  returns to scale ?efficiency gain,
• mark-up rises,
• profitability is restored.
• Result
• bigger, fewer, more efficient firms facing more
  effective competition.
• Welfare gain.

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Market Size Matters

• European leaders always viewed integration as
  compensating small size of European nations.
• Implicit assumption market size good for
  economic performance.
• Facts integration associated with mergers,
  acquisitions, etc.
• In Europe and more generally, globalisation.

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Facts

• MA activity is high in EU.
• much MA is mergers within member state.
• about 55 domestic.
• Remaining 45 split between
• one is non-EU firm (24),
• one firm was located in another EU nation (15),
• counterpartys nationality was not identified
  (6).

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Facts

• Distribution of MA quite varied
• Big 4 share MAs much lower than share of the EU
  GDP.
• I, F, D 36 of the MAs, 59 GDP.
• Except UK.
• Small members have disproportionate share of MA.

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Facts

• Why MA mostly within EU?
• Why UKs share so large?
• Non harmonised takeovers rules.
• some members have very restrictive takeover
  practices, makes MAs very difficult.
• others, UK, very liberal rules.
• Lack of harmonisation means restructuring effects
  very impact by member states.

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Competition Subsidies

• 2 immediate questions
• As the number of firms falls, isnt there a
  tendency for the remaining firms to collude in
  order to keep prices high?
• Since industrial restructuring can be
  politically painful, isnt there a danger that
  governments will try to keep money-losing firms
  in business via subsidies and other policies?
• The answer to both questions is Yes.
• See Chapter 11.

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2. Growth Effects Factor Market Integration

• European leaders have long emphasised the
  pro-growth aspects of European integration.
• These operate in a way that is fundamentally
  different from the way allocation effects
  operate
• They operate by changing the rate at which new
  factors of production mainly capital are
  accumulated,
• Hence the name accumulation effects.

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Verbal logic of growth

• Growth in income per worker requires more output
  per worker.
• Nation's labour force can produce more goods and
  services year after year only if they have
  more/better 'tools' year after year.
• 'tools' means capital broadly defined
• physical capital (machines, etc.),
• human capital (skills, training, experience,
  etc.) and
• knowledge capital (technology).
• ERGO, rate of output growth is linked to rate of
  physical, human and knowledge capital
  accumulation.
• Most capital accumulation is intentional and it
  is called investment.
• Thus European integration affects growth mainly
  via its effect on investment in human capital,
  physical capital and knowledge capital.

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Verbal logic of growth summary

• European integration (or any other policy) ?
  allocation effect ? improved efficiency ?
  better investment climate ? more investment in
  machines, skills and/or technology ? higher
  output per person.
• Medium run effects eventually fade out.
• Growth returns to its long-run rate.
• Long run effects raise long-run rate forever.

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Some facts
Table 7-1 European Growth Phases, 1890-1992
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Some facts
Growth in the WWII Reconstruction Phase.
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Some facts
GDP per capita Rankings, 1950 and 1973 (1990
international dollars).
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Real GDP growth in MS, 2006-2007
Source http//www.stat.si/doc/pub/00-RP-909-0703.
pdf http//www.stat.si/doc/pub/00-RP-909-0802.pdf

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Investment in physical capital in MS, 2006
Source http//epp.eurostat.ec.europa.eu/portal/pa
ge?_pageid2693,70381876,2693_70592044_dadportal
_schemaPORTALYB2
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Expenditure on education in MS, 2004
Source http//epp.eurostat.ec.europa.eu/portal/pa
ge?_pageid2693,70381876,2693_70592044_dadportal
_schemaPORTALYB2
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Expenditure on RD in MS, 2004
Source http//epp.eurostat.ec.europa.eu/portal/pa
ge?_pageid2693,70381876,2693_70592044_dadportal
_schemaPORTALYB2
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Readings

• Basic
• Lecture notes (ppt presentation)
• BW Sub-chapters 6.1, 6.4., Chapter 7
• Additional
• BW Rest of Chapter 6