Mr. Massimo M BeberFellow in Economics

Sidney Sussex CollegeCambridge CB2 3HU

mb65@cam.ac.ukwww.people.pwf.cam.ac.uk/mb65/mpes

European EconomicsLecture 1

Economic Integration:

Definition, Measurement, and Macroeconomic Significance

(Provisional Version: last updated 8th October 2007)

M.Phil. in Contemporary European Studies 2007/8

©Massimo M Beber 2007

Lecture 1 - Objectives

• Key Concepts– Absolute and Comparative Advantage– International Division of Labour (Specialisation)– Payments Adjustment– Macroeconomic (Income-Expenditure) Equilibrium– The Flow of Funds Framework– Foreign Economic Policy: a Classification

• Key Metrics– Openness (trade, finance, migration)– Performance (growth, inflation, unemployment)– Sustainability (environmental, social, ethical)

Comparative vs Absolute Advantage

• England• 1 worker=3 wine barrels• 1 worker=6 wool bales• Wage=£18• Price of Wine=£18/3=£6• Price of Wool=£18/6=£3• Relative price=2 bales

per barrel

Portugal• 1 worker=2 wine barrels• 1 worker=3 wool bales• Wage=£18• Price of Wine=£18/2=£9• Price of Wool=£18/3=6• Relative price=1.5 bales

per barrel

Automatic International Adjustment

Gold Outflow

Trade Deficit

No offsetting capital inflows

“Rules of the game” apply in the deficit country

Prices fall

Money stock falls

Quantity theory of money

Other countries also respect the “rules of the game”

Responsive demand, both on the export and on the import side

Real Depreciation

Trade Balance

Macroeconomic Equilibrium

Resources– Gross Domestic Product– Imports

Domestic Production• GDP

Uses– Domestic Absorption

• Private Consumption• Investment• Public Consumption

– Exports

Total Expenditure• Domestic Absorption

plus Net Exports

THE CIRCULAR FLOW OF INCOME

Business Sector Household Sector

Public Sector

Financial Sector

Foreign Sector (RoW)

Total Output/Income/GDP

Net Taxes

Net Savings

Imports

Consumers’ Expenditure

Public Expenditure on Goods and Services

Business Investment

Exports

Changes in Absorption and Trade behind GDP Growth - Euro Area 2006

Source: Commission Services (European Economy News website, October 2006

The Flow of Funds Framework

• Saving equals income (GDP) less consumption• Private savings is disposable income less consumption• Public saving is tax revenue less public expenditure• National (private and public) savings is GDP (net of taxes)

less consumption, less the public sector deficit• National saving equals the trade balance

• NS = [(Y-T)-C] – (G-T) = Net Exports≈Current Balance

TYPES OF INTERNATIONAL PAYMENTS

CURRENT ACCOUNT +

CAPITAL ACCOUNT =

BALANCE OF PAYMENTS =

ACCUMULATION OR LOSS OF RESERVES

UK BALANCE OF PAYMENTS, 1992

CATEGORY OFTRANSACTION

GROSS FLOWS(% GDP)

BALANCE(% GDP)

Visible Trade (1) 38.2 - 2.2Total Invisibles (2) 35.6 0.8- Services 5.5 1.0- Travel 3.2 - 0.6- Sea & Air Transp. 2.8 - 0.2- Financial 3.9 1.8- Investment Income 22.8 1.0- Unilateral Transfers 2.5 - 0.9CURRENT ACCOUNT (1+2) 73.8 - 1.4Bank Lending to Non-residents 16.8 3.0Portfolio Investment 9.1 - 2.2Foreign Direct Investment 3.3 -0.2CAPITAL BALANCE 28.9 0.6BALANCE OF PAYMENTS - 0.8CHANGE IN OFFICIAL RESERVES - 0.2BALANCING ITEM 0.6Source: Calculations from Financial Statistics, Central Statistical Office (various tables;rounding differences).

Mobility of Capital and

Labour

Microeconomic Policy Co-ordination

Common Macroeconomic

Policy

No internal tariffs

Common External Tariff

FREE TRADE AREA y n n n n

CUSTOMS UNION y y n n n

COMMON MARKET y y y n n

SINGLE MARKET y y y y n

EMU y y y y y

Trade in Goods and Services

Source: a version of a Table introduced by Bela Balassa in The Economics of Integration (1961)

ECONOMIC INTEGRATION: A CLASSIFICATION

LONG TERM GROWTH RATES OF INDUSTRIAL COUNTRIES

(Annual Average % Change of GDP and Exports)

COUNTRY 1870-1913 1894-1913 1950-1972 1973-1993

GERMANY 2.8 (4.1) 3.3 (6.2) 6.1 (12.3) 1.9 (5.2)

FRANCE 1.6 (2.7) 1.8 (9.7) 5.1 (8.1) 2.4 (5.0)

ITALY 1.5 (2.2) 2.7 (3.2) 5.4 (12.0) 3.1 (4.7)

UK 1.9 (2.7) 1.9 (3.7) 2.7 (3.5) 2.5 (3.6)

US 4.2 (4.9) 4.4 (4.1) 3.7 (5.5) 2.4 (6.6)

JAPAN 2.5 (8.5) 2.3 (8.2) 9.7 (15.9) 3.3 (6.4)

AVERAGE G6 2.4 (4.2) 2.7 (5.9) 5.4 (9.6) 2.6 (5.3)

Source: Maddison (1982); European Economy (1993).

LONG-TERM TRENDS IN TRADE OPENNESS

19.4% 19.2%

25.0%

28.4%29.8%

34.8%

4.9% 5.0%

7.8% 8.4%

10.8%9.8%10.5% 9.8%

12.0% 12.3%

9.9%11.1%

0%

5%

10%

15%

20%

25%

30%

35%

40%

1960 1961-1970 1971-1980 1981-1990 1991-2000 2002

Source: European Economy Annual Review (2003), Statistical Annex

Tota

l E

xpo

rts a

t C

urr

ent

Pri

ces,

% o

f G

DP

EURO-15 USA JAPAN

The Direction of EU Good Exports

20%

30%

40%

50%

60%

70%

80%

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Source: AMECO Database

Intr

a-E

U E

xpo

rts

as %

of

To

tal E

xpo

rts

EU=15 EU-25

The Direction of EU Good Exports

20%

30%

40%

50%

60%

70%

80%

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Source: AMECO Database

Intr

a-E

U E

xpo

rts

as %

of

To

tal E

xpo

rts

Italy France UK Denmark

FORTRESS EUROPE? TRENDS IN MERCHANDISE TRADE

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1960 1961-1970 1971-1980 1981-1990 1991-2000 2002

Source: European Economy Annual Review, Statistical Annex

Me

rch

an

dis

e E

xp

ort

s,

% G

DP

UK (intra-EU) UK (extra-EU) EU-15 (intra-EU) EU-15 (extra-EU)

BALANCE OF PAYMENTS TRENDS

0.2% 0.6%

2.3% 2.4% 2.3%

0.4%

-0.1% -0.3%

0.1%

-0.1%

0.4%

-0.2%

-1.0%

-1.4%

-2.9%

0.6% 0.2%

-1.7% -1.7%

-3.3%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

1960s 1970s 1980s 1990s 2002

Source: European Economy

Cu

rre

nt

Ba

lan

ce

(%

of

GD

P)

JAPAN EURO-15 UK USA