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Economics of European Integration

EC4333, Lecture 1

Dr Stephen Kinsella

Department of Economics, KBS, University of [email protected], www.stephenkinsella.net

November 17, 2009

Dr Stephen Kinsella (University of Limerick) EC4333, Economics of EU Integration November 17, 2009 1 / 18

Today

1 Module Outline, Grading, & expectations

2 Outline of lectures

3 Defining Integration

4 Scope of the module

5 Some Facts about the EU


Learning Outcomes

conversant with the historical literature on the development of the EUhaving written several thousand words on the subject;

understand transaction-cost analysis, institutional analysis, optimalcurrency area theory and simple models of capital and labour marketintegration and be able to apply these theories to current practicefollowing the problem sets given in class;

conversant with the Solow model of economic growth, theory andpractice of covergence, and able to assess the empirical reality ofthese claims;

knowledgeable about EU social and environmental policy and theirimpact on the Irish economy.


Grading

Final exam, 50%. 2 Sections. 10 short qs, then 3 from 4 longerquestions. Sample exam week 8.

2 Problem Sets, 15% each

1 Essay, 20%

Essay

Briefly discuss the development of the European Union through the treatystructure. Discuss the potential costs and benefits of the Lisbon Treaty’sratification for the Irish economy.


Policies/Expectations

Lecture slides/podcasts/handouts up after lecture

Notes given out at end of class

Fast email turnaround, normally less than 1 day. Email to:[email protected].

If no reply, email again. Prob. Spam.

On pain of spiky, scary death, do not send me text messages as

emails. I will cut your ears off, rub the stumps in salt, and play

Moby into them.

Come see me whenever, email for a time. No office hours. Office isKB3-42/

Written feedback on all submitted work

Any questions in class, just ask.

Discussion is preferable to lecturing


Outline

1 History, Structure, Institutions

2 OCA/EMU Theory

3 Size & Scale Effects, growth & development

4 Macroeconomics, economic inequality in the EU

5 Location effects, international trade, Ireland and the EU.


Defining Integration

Debate runs like this

Trade liberalisation vs economic integration–Goes further–Discriminatory

Trade arrangements can differ”

1 Barriers to trade in goods

2 Barriers to services trade

3 Barriers to trade in productive factors

4 Corporate behaviour

5 Government behaviour


EU: Economic solution to a political problemHow can Europe avoid another war?

Country Death Toll Economic Setback to Year’s GDPAustria 525,000 1886Belgium 82,750 1924Denmark 4,250 1936Finland 79,000 1938France 505,750 1891Germany 6,363,000 1908Italy 355,500 1909Netherlands 250000 1912Norway 10,250 1939-45Sweden 0 1939-45UK 325,000 1939-45

Source: Crafts and Toniolo: Economic Growth in Europe since 1945(Cambridge: CUP,1996, p. 4)


Causes of the Second World War

Three answers:

Germanycapitalismdestructive nationalism.

3 post-war solutions:

‘neuter’ Germany via Morgenthau Plan, 1944adopt communismpursue European integration.European integration ultimately prevailed, but this was far from clearin the late 1940s.

Depended on causes. Three schools of thought:

The problem/The solutionThe loser (Germany) / De-industrialisationCapitalism / CommunismIntegration. Cold war pushed US, UK, France towards strongGermany and integration


Steps taken to EU-handout


Big IdeasSee Treaty of Rome, 1957, www.ena.lu/

Free trade in goods

Common Trade policies (Lisbon)

Help ensure undistorted competition1 Prohibit State Aid2 Prosecute Anti Competitive Behaviour3 Reduce distortionary taxes (Irish Corporation Tax)

Allow trading in services

Labour/Capital market integration

Exchange rate coordination

Common social, regional, agricultural, eventually taxation approaches


Structures to house these ideasUnderneath the banner of the EU sit:

Competencies vs supranationality

European Commmunity

Common foreign/security policy (Lisbon)

Justice, Home affairs

All underpinned by treaty law.


Budget

Figure: Evolution of EU Budget.Dr Stephen Kinsella (University of Limerick) EC4333, Economics of EU Integration November 17, 2009 13 / 18

Population

Figure: PopulationDr Stephen Kinsella (University of Limerick) EC4333, Economics of EU Integration November 17, 2009 14 / 18

Net Contribution by member

Figure: Net Contributions by MemberDr Stephen Kinsella (University of Limerick) EC4333, Economics of EU Integration November 17, 2009 15 / 18

An index of Integration

Figure: Index of Economic Integration.Dr Stephen Kinsella (University of Limerick) EC4333, Economics of EU Integration November 17, 2009 16 / 18

Next Time:

Institutions of Economic and Monetary Union, development of currentpolicies and prospects for the future. Models of Customs Unions forProduct and Factor Markets and empirical results on levels of integrationacross these markets Readings:

Baldwin & Wyplosz, Chapters 1 and 2 and 3.

Eichengreen, B. The European Economy since 1945, MIT Press, 2007.

* Beach, D., The Dynamics of European Integration, pgs. 1–31, andpgs. 214–244, 337.142 BEA.

El-Agraa, A.M., The European Union: Economics and Policies, 6thed., pgs 1-19 and 72-79, 337.142 AGR.

McDonald, F. and Dearden, S. European Economic Integration, 3rded., pgs 34-53, 337.142 MCD.



Lecture 2

Stephen Kinsella

Dept. Economics,University of [email protected]

November 17, 2009

Stephen Kinsella (University of Limerick) Economics of European Integration November 17, 2009 1 / 16

Last Time

Summary 1

The EU is an economic solution to a political problem: how do we avoidanother war?

Summary 2

EU’s history, and its treaty structure, defines the set of choices it canmake now and into the future. History matters.


Today

1 The Legal System in the EU

2 Institutions of Economic & Monetary Union

3 Big Institutions

4 Decision Making

5 Lisbon

6 Some Microeconomics/models of Customs Unions


Learning Outcomes

Understand EU institutions & legal structures

Understand how these institutions promote, enhance, and enmesh EUintegration. (2).

Understand what the Lisbon treaty is, what it might do, and why itfailed the first time.

Refresh your microeconomics.


Sources of EU Law

Treaty of Rome established the EU legal system.EU law is established on the basis of:

The EU institutions ensuring actions by the EU take account of allmembers’ interests, i.e. the Community’s interest;

The transfer of national power to the Community.

Key Ideas:

1 Autonomy. System is independent of member states.

2 Direct Applicability. EU law is law everywhere.

3 Primacy of Community law. EU law gets final say.


Pillar Structure

Figure: Legal Structure of the EU, pre-Lisbon.


Types of LegislationBrilliant resource: http://eulaw.typepad.com/

1 Primary: Treaties2 Secondary: Collective decisions

� Regulations: In force everywhere instantly.� Directives: Apply to some states, only end goal specified� Decisions: single legislative act for company, person, country� Recommendations: not legally binding, can change behaviours� Opinions: same.


Big EU Institutions

European Council. V. influential.

Council of Ministers. Exactly what it says on the tin.

Commission. Administers, implement EU policies

Parliament. Shares legislative power (including budgetary power) withCouncil and Commission

EU Court of Justice. Court has had a major impact on Europeanintegration via case-law. (eg. Aer Lingus & Ryanair.)

ECB. European Central Bank

Questions of Democracy & Accountability


QMV

Qualified Majority Voting,


Core Idea of Lisbon

“The good life” which the EU is supposed to promote is not just the‘economic’ good life, but the good life more generally defined.

Line 1 of the Lisbon Treaty: “The Union’s aim is to promote peace,its values, and the well being of its peoples”

Line 1 (Article 2) of the Treaty of Rome: “It shall be the aim of theCommunity, by establishing a Common Market and progressivelyapproximating the economic policies of Member States, to promotethroughout the Community a harmonious development of economicactivities, a continuous and balanced expansion, an increased stability,an accelerated raising of the standard of living and closer relationsbetween its Member States.”

(See http://www.ena.lu/ for fulltext articles)


LisbonWhat is it?

What is it? Lisbon Amends Previous Treaties.Why? Streamline Bureaucracy; allow for accession countries, entry,

expand competenciesWhat Changes? Presidency, Introduce Qualified Majority Voting → No

Vetos; EC Council; Foreign affairs reps; fewer MEPS;Defense Policy→ Mutual Assistance; Climate Change/EnergyPolicy/Human Rights competencies :(Exclusive/Joint/National)

What does it mean? Keywords: “Streamlining, expanding, enhancing”, via

1 Common Values2 Common Justice3 Common Foreign Affairs4 Common Defense5 Common Climate Change6 Common Voting Rules


Why did Lisbon 1 fail?

3 basic reasons:

1 O’Rourke: Class, see http://voxeu.org/index.php?q=node/1233

2 ECB: Economy, See (1).

3 FF: < Preparation


What’ll happen on October 2nd?Things are different this time

1 Surge in unemployment, economy in turmoil (NAMA), high levels ofuncertainty about the future.

2 Implies fear generated by ‘yes’ campaigners of isolation from EU moreeffective

3 However, much more likely to create a backlash against FF again.4 Also, TDs only devoting 2 weeks to campaigning for Lisbon→ Less

preparation.

Figure: Irishtimes.com poll, August 2009.


To the Blackboard, Batman!


Next Time

1 Economics of Preferential Liberalisation

2 Theories of Monetary Union

Get your read on:

Baldwin & Wyplosz, Chapter 5.

* Buiter, W.H. “The Economic Case for Monetary Union in theEuropean Union”, in Deissenberg, Owen and Ulph, eds. European

Economic Integration, published as a supplement to the Review ofInternational Economics, Vols. 4-5., pgs. 10–35. 337.142 DEI.

Hansen, J.D., European Integration: An Economic Perspective,Oxford University Press, 2001, 1st ed. pgs. 163-189, 337.142 DRU.

Healey, N. ‘Economic and Monetary Union’, in McDonald, F. andDearden, S. European Economic Integration, 3rd ed., pgs. 94–114,337.142 MCD.

Wyplosz, C. ‘European Monetary Union: The Dark Sides of a MajorSuccess’, Economic Policy, 2006


References

[1] Stefan Griller. The Lisbon Treaty: EU Constitutionalism Without a

Constitutional Treaty? Springer, 2008.

[2] Susan Senior-Nello. The European Union: Economics, Policies, and

History. McGraw-Hill, 2008.


Economics of European IntegrationLecture 3

Stephen Kinsella

Economics, UL

November 17, 2009


Quick Recap

1 EU is an economic solution to a political problem

2 History of integration matters, and reflects current level of integration

3 There are welfare effects to greater integration: microeconomic

analysis can help us understand these effects.


Today

1 Let’s get our model on

2 Welfare Analysis


Data to Explain (1)


Data to Explain (2)

Figure: captionStephen Kinsella (University of Limerick) Economics of European Integration November 17, 2009 5 / 23

Demand


Supply


Consumer Surplus

T

h

e

i

m

price

p*

quantity c*

Triangle is sum of all gaps between marginal utility and price paid (summed over total consumption)

Demand

curve =

MU


Consumer Surplus (2)

price

p*

quantity

Demand curve

c*

p ’

c ’

A B


Import Demand/Supply


Welfare Analysis

euros

imports quantity

MS

MD

Z C

Domestic

price, euros

Import

supply curve

Domestic demand curve Domestic

supply curve

Imports

Import

demand curve

Imports

Sdom

Ddom

PFT


Right, enough of that. Moving onto customs unions.

European integration involved a sequence preferential liberalisations

but all of these were reciprocal.

Eg: both Home & Partner drop T on each other’s exports Need to

address the 3-nation trade pattern.


3 big increases in EU economic integration

1 Formation of the Customs Union, 1958- 1986

2 Single Market program, 1986-1992

3 European Economic and Monetary Union, 1992-present


Stage of Integration

Stage Internal Common Factor Common Common

of Integration Barriers Ext.Tariffs Mobility Currency Ec. Policy

FTA X

CU X X

Single Mkt X X X

Monetary Union X X X X

Economic Union X X X X X


Transactions Costs

Increased economic integration through stages:

1 EMU

2 Common market

3 Economic Union

4 Customs Union

5 Free Trade Area

Generates increases in efficiency and decreases in transactions costs

through Legal, Regulatory, taxation, public procurement, economic and

social policies.

See www.europa.eu.int/pol/tax


Basic Idea: Promote Free Trade

Definition (Free Trade)

Absence of tariffs, quotas, or other governmental impediments to

international trade.

Why is trade good?1 Gains from Specialisation

2 Gains from trade

3 Ricardo’s Big Idea.

This creates larger markets, greater access to raw materials, and more

competition. The happy ending should be lower unit costs, since firms are

able to gain economies of scale. From the consumers’ point of view, lower

prices and greater choice should make them happy too.


Effects of Economic Integration

1 Location Effects. Changes to Growth Patterns caused by extra

investment in home country.

2 Accumulation Effects. Convergence with other countries.


Trade Creation/Destruction

Definition (Trade Creation)

The increase in trade volume caused by union with a lower cost (more

efficient) supplier within the trade bloc–(1)

(Trade Destruction is the opposite).


Estimates of Trade Creation/Trade Diversion

(bn) % GDP

(a) (b) (a) (b)

Barriers to trade 8 9 0.2 0.3

Technical Regs 57 71 2.0 2.4

Ecs. of Scale 60 61 2.0 2.4

X-inefficiency 46 46 1.6 1.6

Total 171 187 5.8 6.4

(At 1985 Prices)

Source: Cecchini Report, Emerson et al, 1988.


Price Dispersion (Coefficient of Variation)

1985 1993 1996

Private Final Consumption 21.9 15.9 15.9

Government final cons. 25.4 25.9 27.2

Gross fixed capital formation 12.8 14.5 13.5

Construction 19.2 23.6 22.0

Machinery 9.1 6.7 7.7

GDP 20.1 16.2 16.3


Summary

1 Let’s get our model on

2 Welfare Analysis


Next Time

Get your read on:

El-Agraa, A.M., (2002), The European Union: Economics and

Policies, 6th ed., pgs. 149–164, 337.142 AGR.

Wyplosz, C. ‘European Monetary Union: The Dark Sides of a Major

Success’, Economic Policy, 2006.

Healey, N. ‘Economic and Monetary Union’, in McDonald, F. and

Dearden, S. European Economic Integration, 3rd ed., pgs. 94–114,

337.142 MCD.


References

[1] Jacob Viner. The Customs Union Issue. Carnegie Endowment, New

York, 1950.



Stephen Kinsella

University of [email protected]

November 17, 2009


Today

1 Economic and Monetary Union

2 Optimum Currency Area Theory

3 Costs and Benefits of EMU

4 Ancient Rome: This too shall pass


Learning Outcomes

1 Analyse effects of preferential liberalisation using MS/MD apparatus.

2 Describe optimal currency area theory and criteria

3 Understand EMU, and its costs and benefits.


Part One of Four. Preferential Liberalisation


Preferential Liberalisation: MS-MD Equilibrium

Domestic price

Home

imports

MD

PFT

RoW

Exports

Partner

Exports

XSP XSR MS

M=XP+XR

Partner Home RoW

Border price

2 1

XP X

R


Preferential Liberalisation

Consider Home removes T on imports only from Partner

1st step is to construct the new MS curve The liberalisation shifts upMS (as with MFN liberalisation) but not as far since only on half ofimports

Shifts up MS to half way between MS (free trade) and MS (MFN T ),but more complex, kinked MS curve with PTA.


Comparative Statics

Domestic price

Home

imports

MD

PFT

RoW

Exports

Partner

Exports

XSP XSR MS

MSMFN

P’

M’ M=XP+XR

Partner Home RoW

Border price Border price

T

P’-T

2 1

X’R X’

P

XP X

R


What happens to domestic prices?

domestic price falls to P � from P ��

Partner-based firms see border price rise, P � − T to P ��

RoW firms see border price fall from P � − T to P �� − T .


Home/Border Effects

Domestic price

MD

XSP XSR

MS

MSMFN

M’

Border price Border price

MSPTA

P’

T

P”

P’-T

P”-T

XR” XR’ XP’ XP” M”

P’-T

P”


Welfare Effects of Customs Union Formation1 In market for good 1, Home change = A + B − C1− C22 In market for good 2, Home change = +D1 + D2, and (D1 = C1)3 Net Home impact = A + B − C24 Partner impact identical. RoW loses big time.

euros

imports

MD

euros

Exports

XS

M’

A

D 2

D 1 C 1

B

C2

XP” XP’ XR” XP’

P’-T

P”

P’

P”-T

CU vs FTA

FTA like CU but no Common External Tariff

Opens door to ‘tariff cheats’, goods from RoW destined for Homemarket enter via Partner if Partner has lower external tariff, called‘trade deflection’

Solution is ‘rules of origin’ meant to establish where a good was made.

Problems: Difficult and expensive to administer, especially as worldget more integrated

Rules often become vehicle for disguised protection.

Despite the origin-problem in FTAs, almost all preferential tradearrangements in world are FTAs.


Part Two of Four. Optimal Currency Areas


OCA Theory

Mundell (1961), Kenen (1969), Tavlas.

See Francesco Mongelli ECB Article.

Basic Idea: when it is a good idea for 2 or more countries to share acurrency?

Definition (Optimum Currency Area)

[T]he optimal geographic domain of a single currency, or of severalcurrencies, whose exchange rates are irrevocably pegged and might beunified. The single currency, or the pegged currencies, can fluctuate onlyin unison against the rest of the world.


A region is optimal as an OCA to the extent it exhibits:

Labour & factor mobility

Financial market integration. Ingram (1962) noted that financialintegration can reduce the need for exchange rate adjustments.

Production diversification

Openness

Fiscal transfers & fiscal integration

Homogeneous preferences

Commonality of destiny & political integration

OCA theory suffers from problems of inconclusiveness and inconsistency.How can one rank different OCAs? The EMU question is, possibly, morecomplex than the OCA question. Tools just not sophisticated enough.


Specialisation versus “Endogeneity of OCA”

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Due to the need for relatively long time series for the econometric tests, studiesinvestigating OCA properties are by necessity backward looking. Such studies cannot reflecta change in policy preferences, or a switch in policy regime. In fact, monetary integrationwould represent a structural break for any group of countries adopting a new single currency.A question naturally arises: what type of forces might monetary integration unleash? Lookingahead, we may be confronted with two distinct paradigms -- specialisation versus endogeneityof OCA -- which have different implications on the benefits and costs from a single currency.

6. A Tale of Two Paradigms: Specialisation versus “Endogeneity of OCA”

Frankel (1999) singles out two OCA properties as crucial in assessing the net benefitsfrom currency union: their degree of openness, i.e., the extent of reciprocal trade among agroup of partner countries, and their correlation of incomes (capturing over time diverse otherproperties). Countries sharing a high level of eitheropenness or income correlation , butpreferably both properties, will find it beneficial to share a single currency as illustrated inFigure 2. Their trade-off is illustrated by the downward sloping “OCA line” that shows thecombination of openness and correlation of incomes beyond which the advantages from acommon currency would dominate for a group of partner countries. To the left of the OCAline instead the advantages from monetary independence dominate. The US States and thecurrent members of the euro area (according to us) are located on the right of the OCA line:i.e., they draw net benefits from respectively the US dollar and the euro. Among a groupformed by the US, Japan and Europe the advantages from monetary independence wouldinstead dominate: these countries as a group lie instead on the left of the OCA line.

Frankel also notes that the optimum currency area properties evolve over time. Mostauthors agree that reciprocal trade and openness increase among countries sharing a singlecurrency and a common monetary policy in response to a decline in transportation costs and amore stable exchange rate regime. A case in point are the members of the European Unionthat have removed all trade and financial barriers among each other and share a single market.Reciprocal trade has constantly risen among these countries. Statistical estimates usinggravity model of bilateral trade suggest that membership in the EU increases trade with itsmembers by over 60 percent (Frankel and Wei (1998)). There is disagreement thoughconcerning the extent by which income correlation rises or falls following monetary

Advantages ofcommon currencydominate

Advantages ofmonetaryindependencedominate

OCA Line

Extent of trade among membersof group (Openness)

Correlation ofincomesamong group

Figure 2. Two Key Optimum Currency Area Properties

JapanEU

USA

SwedenUK

Denmark

EuroArea

USStates


Part Three of Four. Costs and Benefits of EMU.


Costs of EMU

1 Loss of Flexibility: can’t devalue, less autonomous monetary policy forall

2 Asymmetric Effects of macro shocks

PO PC

YOYC

DO

SO

DC

SC

Very open country Relatively closed country


Benefits of EMU

Lower transactions costs

More price transparency

Less uncertainty

More economic growth


Part Four of Four. Wome!


Cool example of EMU: Rome

The first European monetary union was the Roman Empire.

Throughout a geographical area larger than today’s EU, Roman coinscame to be the predominant medium of exchange.

The widespread use of Roman money was due in part to the presenceof Roman occupying forces, but also to the increased amount ofinternational trade across the empire. Rome did not decree its money.

This common currency area broke down around the end of 5thcentury AD.

The single most important reason for the breakdown was almostcertainly the loss of financial and political control by the Romans.

Rising political instability made trade more risky and difficult so thatinternational trade integration fell.


Next Time

Growth and development effects in the EU. The logic of growth effects,medium term effects & long term effects.


Badinger, H. Technology and Investment-led growth effects ofeconomic integration. Applied Economics Letters, 15(7), 557-61,2008.

Jones, C. I. Introduction to Economic Growth, McGraw Hill, 2008.



Lecture 5

Stephen Kinsella


November 17, 2009


Today

1 Growth Effects

2 Solow Model of Growth

3 Ireland’s growth experience

4 Labour and Capital Market Integration


Learning Outcomes

Understand the basic story being told about growth in the EU

Explain the Solow model verbally, test it numerically.

Analyse and discuss capital and labour market integration


The Growth ‘Story’

EU is sold as providing huge markets which will generate growth for

individual countries.

EU growth effects are ‘accumulation’ effects

They change the rate new factors of produced get used.

The story runs like this:

1 Growth in income per worker requires more output per worker

2 Nation’s labour force can produce more goods and services year after

year only if they have more/better ‘tools’ every year.

� Tools here means: physical capital (machines, etc.),

� human capital (skills, training, experience, etc.) and

� knowledge capital (technology).

3 rate of output growth linked to rate of physical, human and

knowledge capital accumulation.

4 Most capital accumulation is intentional and it is called investment.

5 Thus: European integration affects growth mainly via its effect on

investment in human capital, physical capital and knowledge capital.


One more time

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 peter out

Growth returns to its long-run rate

Long run effects raise long-run rate forever


Data on EU Growth

Period Real GDP Real GDP per capita Real GDP per hour

1890-1913 2.6 1.7 1.6

1913-1950 1.4 1 1.9

1950-1973 4.6 3.8 4.7

1973-1992 2 1.7 2.7

Whole Period

1890-1992 2.5 1.9 2.6


Idea

Show medium-run growth in the economy by first assuming a single EU,

closed to trade from the outside. Simple diagram, see Jones (2001) or

Romer (2000) for excellent summaries. Also, see the handout.

A

B

K/L

euros/L

GDP/L

s(GDP/L)

!(K/L) Y/L*

K/L* K/Lo

Io

Do


Ireland’s EU Growth Experience

We did well post 1973, through:

External Funding

Large inflow of structural and cohesion funding for the EU had a

beneficial effect on the economy

Demand side effect

Supply side effect

Euro/EMU/Maastricht criteria

Economic criteria (interest rates, inflation rates, level of debt and

exchange rates)

Freer trade


That said...

Demographic Trends

Size and composition of labour force can have a significant impact on

the economic development

Education Profile and Cost of Labour Force

Industrial Investment and Incentives

Exchange Rate Policies

Devaluations of 1986 and 1993

The External Economic Environment


Data

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Figure: caption


Capital/Labour Market Integration

Figure: captionStephen Kinsella (University of Limerick) Economics of European Integration November 17, 2009 11 / 14

Welfare Effects

‘Native’ capital-owners in Home lose A; Home labour gains A + B;

Total economic impact on Home citizens is BForeign capital still employed in Foreign gains F ; Foreign labour loses

D + F ; total impact on Foreign-based factors is −D.

Counting welfare of Foreign capital owners whose capital now works

in Home (gains C + D), so overall Foreign welfare gain is C .

Next Time

Macroeconomics of Monetary Integration. Simple IS-LM analysis, PPP,

Balassa-Samuelson effects, changes in aggregate demand during a

downturn. The trilemma.

Baldwin & Wyplosz, Chapters 9 and 10.

Reinhart, C. and Rogoff, K. The modern history of exchange rate

arrangements: a reinterpretation. Quarterly Journal of Economics,

119(1), 1-48, 2002. See Reinhart and Rogoff’s subsequent work on

crises if you’re interested in economic history.

Eichengreen, B. ‘Sui Generis Euro’, download from Eichengreen’s

Berkeley site.


References

Charles I. Jones. Introduction to Economic Growth. W.W. Norton & Co.,

2001.

David Romer. Advanced Macroeconomics. McGraw Hill/Irwin, 2nd

edition, 2000.



Stephen Kinsella


November 17, 2009


Today

1 Monetary Integration

2 EMS and ECB

3 Mundell-Fleming


Last Time

Growth effects of continued integration1 Recall OCA theory from lecture 42 OCA Criteria partially fulfilled but EU not an OCA.

Ireland’s growth experience from 1973-2009.


Today

Macroeconomics of Monetary Integration

PPP/Balassa Samuelson effects

Choice of exchange rates & the EMS system

The European Monetary System


But firstAdmin :(

PS1 due next Tuesday before class.

Essays handed back next week in tutorials

Teaching assessment, please submit online asap.

Any other questions?


Stages of EMS

1979–83, (unstable international monetary environment)

1983–87, (relatively few realignments)

1987–92, (the ‘hard’ EMS, was characterized by great stability, if notrigidity of exchange rates)

from the 1992 crisis until introduction of the euro in December 1999(widening of most ERM margins).


Key Moments (1)

The 1969 Hague Summit envisaged EMU by 1980, but the initiativefailed in the face of the monetary instability of the 1970s.

The ‘snake in the tunnel’ was created in 1972, but by 1973 this hadbecome a ‘joint float’ of currencies linked to the D-mark against thedollar.

The European Monetary System was launched in 1979 and entailed:the exchange rate mechanism, introduction of the ECU, a divergenceindicator and monetary co-operation. The ECU was the forerunner ofthe euro, and the European Monetary Institute provided theinstitutional basis on which to build the future European CentralBank.


Key Moments (2)

The operation of EMS can be divided into four periods: 1979–83,1983–87, 1987–92 and the 1992 crisis and after. From August 1993,the bands of fluctuation were widened to +/– 15 per cent.

Padoa-Schioppa (1987) refers to the ‘contradictory quartet’ which nointernational monetary arrangement has been able to reconcilesimultaneously: liberalized trade, free capital movements, fixedexchange rates and autonomy of monetary policy. The more recentliterature usually refers to an impossible trinity as trade liberalisationis usually taken for granted.


Key Moments (3)

The 1993 Maastricht Treaty set out the criteria for joining the singlecurrency, the timetable for its introduction and the main institutionalfeatures of EMU.

The Maastricht criteria entail that successful candidates must haveinflation rates no more than 1.5 per cent above the average of thethree countries with the lowest inflation rate in the EU; long-terminterest rates no more than 2 per cent.


The Impossible Trinity, the contradictory quartet

Schioppa (1987) refers to the ‘contradictory quartet’ that no internationalmonetary arrangement has been able to reconcile simultaneously:

Liberalized trade;

Free capital movements;

Fixed exchange rates; and

Autonomy of monetary policy.


Convergence CriteriaBasic Idea

Interest rate convergence

Public finance discipline

Exchange rate stability

Price stability


Convergence CriteriaMore specifically

Inflation Not to exceed by more than 1.5% the average of the threelowest rates among EU countries

Long-term interest rate Not to exceed by more than 2% the averageinterest rate in the three lowest inflation countries

ERM membership At least two years in ERM without being forced todevalue

Budget deficit Deficit less than 3% of GDP

Public debt Debt less than 60% of GDP


The Euro System and the European System of CentralBanksSee http://www.ecb.int/home/html/index.en.html

European Central Bank (ECB): The relationship between the ECB and theEurosystem resembles the federal banking system of Germany or the USA.


Structure of the Eurosystem(See Gerdesmeier, Mongelli and Roffia, 2007)

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9ECB

Working Paper Series No 742March 2007


Tasks of the EurosystemSee Baldwin, Berglof, Giavazzi, Widgren, ‘Preparing the ECB for enlargement’, CEPRPolicy Paper, No. 6, Centre for Economic Policy, 2001.

‘To maintain price stability’.

‘To support the general economic policies in the Community’.

‘To define and implement the monetary policy of the Community’.

‘To conduct foreign exchange operations’.

‘To hold and manage the official foreign reserves of the memberstates’.

‘To promote the smooth operation of payments systems’

‘To contribute to ‘the smooth conduct of policies pursued by thecompetent authorities relating to the prudential supervision of creditinstitutions, and the stability of the financial systems’.


Fundamental Task of the Eurosystem

The primary objective of the ESCB shall be to maintain pricestability. Without prejudice to the objective of price stability, theESCB shall support the general economic policies in theCommunity with a view to contributing to the achievement ofthe objectives of the Community as laid down in Article 2.

The Maastricht Treaty’s Art.105


2 Pillar ECB Strategy

The monthly Eurosystem’s interest rate decisions (every month) rests ontwo pillars:

1 Economic analysis ( Broad review of economic conditions, Growth,employment, exchange rates, abroad Monetary analysis)

2 Evolution of monetary aggregates (M3, etc.)


Differences of function between ECB and Fed/BoJ

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12ECB Working Paper Series No 742 March 2007

9B

9B

Mundell-Fleming

The Mundell–Fleming model can be used to show the effects of monetarypolicy and fiscal policy with fixed and floating exchange rates and perfectcapital mobility.The IS curve illustrates the various combinations of interest rates (i) andnational income (y) that yield equilibrium in the goods market. It isnegatively sloped, since lower interest rates are associated with higherlevels of investment and income (and higher saving and imports) for thequantities of goods and services demanded and supplied to remain equal.The LM curve illustrates all the points at which the money market is inequilibrium


Mundell-Fleming Model

i (%) LM LM’ E E’ i=i* BP = 0 IS’ IS National income (Y)

The effects of fiscal and monetary policy in differentexchange rate regimes

Fixed exchange rate Flexible exchange rateMonetary policy ineffective effective

Fiscal policy effective ineffective


PPP and the Balassa-Samuelson effect

Definition (Purchasing Power Parity)

For a given basket of goods, over time, in 2 countries, the prices shouldequalise, or PA = e × PB .

Definition (Balassa Samuelson)

Predicts that consumer price levels in wealthier countries are systematicallyhigher than in poorer ones, because productivity growth-rates vary more bycountry in the traded goods’ sectors than in other sectors

Definition (Stolper Samuelson)

A rise in the relative price of a good will lead to a rise in the return to thatfactor which is used most intensively in the production of the good, andconversely, to a fall in the return to the other factor.


Fiscal policy in a monetary union

Lessons of OCA theory:

it is preferable to have a large enough federal budget to compensatefor the asymmetric shock;

that fiscal policy should be used in a flexible way to compensate forthe asymmetric shock.

(Automatic vs. discretionary fiscal stabilisers)

Cyclical income spillovers

Borrowing cost spillovers

Spillovers associated with excessive deficits


Next Time

Competition Policies, Regional Policies and Environmental Policies in theEU.


* El-Agraa, A.M., The European Union: Economics and Policies, 6thed., pgs. 388-399 and 187-199, 337.142 AGR.

Pelkmans, J. European Integration: Methods and Economic Analysis1st ed., pgs. 164–182. 337.142 PEL.


Economics of EU IntegrationLecture 7

Competition Policies, Regional Policies, and Environmental Policies

Stephen Kinsella

Dept. Economics, KBS, [email protected]

November 17, 2009

Stephen Kinsella (UL) EC4333 November 17, 2009 1 / 23

Today

1 Competition Policy: Where it came from, what it is, how it works

2 Regional Policy: what it claims to do

3 Environmental policy: what it might do in the future.


Part I

Competition Policy


Why do we need competition law?

EU Competition policy attempts to ensure markets

remain competitive (Anti-trust/caterls/mergers control)

become more competitive (liberalization)

maintain level playing field (state aid)

Benefits of competitive markets in the EU

ensures the competitiveness of industry

may lead to technological innovation

produce benefits for consumers (lower prices)


History of Competition Policy in EEC/EU

1951 European Coal and Steel Community (ECSC)1 Antitrust and merger rules for coal and steel2 Concept of supranationality EC Treaty

1957 agreement on ambitious competition law (except mergercontrol)

1989 Direct exclusive competence of European CommissionIntroduction of Merger Control Decentralization of the powerto apply antitrust rules

2004 Sharing of competence between European Commission andMember States’ competition authorities

2009 Lisbon?


Important Legal Pillars

1 Article 81: No Cartels, no anti competitive agreements

2 Article 82: No Abuse of Dominance

3 Article 86: Liberalization

4 Article 87: State Aid Controls

5 Reg. 139/2004: Merger Control

See Massimo Motta, Competition Policy: Theory and Practice, CUP, 2004.


Benefits of Competition Law Enforcement?

Air transport liberalisation: Market entry of low cost carriers(Ryanair’s average European fare ca. 40 eurs / British Airways 268euros)

Air transport cartel: SAS / Maersk cartel (ticket prices increased50%)

Mobile telephony liberalisation: (OECD study)

(See http://europa.eu.int/comm/competition/)


Costs of Collusive Behaviour

From Art. 81(1): Collusive behaviour is considered contrary to consumerinterests when it entails agreements to:

Raise prices;

Restrict output, markets, technical development or investment;

Share markets or sources of supply;

Apply dissimilar conditions to equivalent transactions with othertrading parties;

Make the conclusion of contracts subject to supplementaryobligations.


Mergers and Acquisitions

M&A activity is high in EU.

Much M&A is mergers within member state:

about 5 per cent ‘domestic’

remaining 45 per cent split between:

one is non-EU firm (24 per cent),

one firm was located in another EU nation (15 per cent)

counterparty’s nationality was not identified (6 per cent).


Economic Logic of M&A

Liberalise markets (open them up)→De-fragmentation (imperfectlycompetitive firms now face overseas competitors)→ →Pro-competitiveeffect→Industrial restructuring (M&A, etc.) =⇒ RESULT: fewer, bigger,more efficient firms facing more effective competition from each other .


Industrial Policy in EU

Big idea: use industrial policy to increase competitiveness for benefitsdescribed above.

Assume imperfect competition, increasing returns to scale.

In the absence of perfect competition firms will change a price that isabove their marginal cost in order to maximize profit

If there are more firms in the market, competition will lower themark-up that each firm can charge

With imperfect competition and increasing returns to scale only agiven number of firms can survive in a market.

The higher the mark-up (or gap between prices and marginal cost)the more firms can survive.

The break-even curve (or zero profit curve) shows how many firmscan break even at each level of mark-up


Relationship summarised in BE-COMP Diagram

5 (Deriving the Comp curve in the BE-Comp diagram) This question shows how we derive the relationship between choice of mark-up and number of firms that we use in the lectures (the comp curve). Consider a product market with firms subject to increasing returns to scale. Consider the simplest possible form of increasing returns to scale: firms face a fixed cost of operating (f) and a constant marginal cost (c). Demand in this market is isoelasitic: . There are n firms in the market. All firms have identical cost functions. Assume that each firm takes the other firm’s outputs as given when making their own output decision (i.e. assume firms play Cournot)

/1PQ

(i) Write down the perceived marginal revenue curve for each producer. (ii) Use the Cournot assumption and the fact that firms share the market to show that the equilibrium mark-up is such that .)/1( cnP (iii) Use your answer to (ii) to show that cP is decreasing with the number of firms (i.e. to show that the Comp curve is downward sloping). (iv) Do firm’s always break even at this price-marginal cost mark up? 6 (Deriving the BE curve in the BE-Comp diagram) This question shows how we derive the relationship between the break even mark-up and number of firms that we use in the lectures (the BE curve). Technology is as in question 5. Assume that all firms are identical. (i) What is the relationship between price and average costs that ensures that firms break even? (ii) Use this relationship to show that the BE curve slopes upwards (i.e. the mark-up needed to break even increases with the number of firms) 7 (Using the BE-Comp diagram) i) Use a three panel diagram like the one above to show how the number of firms, mark-up and firm size would change in a closed economy if the demand for a particular good doubled. [Based on exercise 6.2 B&W].

Figure: The break-even curve (or zero profit curve) shows how many firms canbreak even at each level of mark-up


Use BE-COMP to think about integration

Assume integration leads to trade liberalisation between two countries:home and foreign.

1 The impact of the trade liberalisation implied by integration is toincrease the size of the market leading to more competition.

2 Increased competition means that the typical firm will have to cut itsmark-up.

3 At the same time the larger market means that more firms cansurvive.

4 This is because the larger market creates opportunities for highersales, so with a given mark-up a larger number of firms can survive.

Can also think about mergers and acquisitions. See paper by [3], also [1,Chapters 6 and 12], and [2].


Part II

Regional Policy


Who is regional policy for?

Less-favoured regions

Areas with specific handicaps

Vulnerable groups in society

Local and regional authorities

Applicant countries


What does it do?

Improving regional competitiveness

Expanding and improving employment

Balanced development in urban and rural areas and areas dependenton fisheries

Embeds other Community policies at the service of the regions

Supports notion of ‘Europe of Regions’

Facilitates loans from the European Investment Bank


Unemployment: A Pressing concern in the EU


Challenges for Regional Policy

Competition

Flexibility of firms due to technological change

Enlargement


Part III

Environmental Policy


There is a problem.


Summary

1 Competition policy is key for economic and monetary union to succeed

2 Regional policy is built on opposite of competition–all about socialcohesion

3 Environmental policy: a lot done, more to do.


References

[1] Richard Baldwin and Charles Wyplosz. The Economics of EuropeanIntegration. McGraw-Hill, London, 3rd edition, 2009.

[2] Michael Burda and Charles Wyplosz. Macroeconomics: A EuropeanText. Oxford University Press, 2nd edition, 1997.

[3] Martina Martynova and L.D.R. Renneboog. Mergers and acquisitionsin europe. Discussion Paper 6, Tilburg University, Center for EconomicResearch, 2006.


Economics of EU Integration

Lecture 8Inequality in the EU

Stephen Kinsella

Dept. Economics, KBS, [email protected]

November 17, 2009


Today

1 Defining Inequality

2 Social Policy & Employment Strategies

3 CAP, Inequality & Reforms by 2013

Admin: Problem set 2 due Tuesday of week 11; sample exam up.


Part I

Inequality in the EU


Inequality is...

Definition (Income inequality)

The ratio of total income received by the 20% of the population with thehighest income (top quintile) to that received by the 20% of thepopulation with the lowest income (lowest quintile).

See http://www.eurofound.eu.int/areas/qualityoflife/eurlife/index.php.

EMU improves economic performance, but is also associated withhigher inequality and lower social spending

Why?

Bertola (2007) found inequality variation associated with EMU is fullyaccounted for by changes in social policy expenditure as a share ofGDP. See http://voxeu.org/index.php?q=node/600.

Notion of ‘inequality tolerance’


How bad is it?

Figure: Inequality in EU over time. Source: Bertola, (2007)


Gini for EU-27Recall: GINI = 0, equal, GINI = 1, unequal. Lowest is Sweden with 0.23, highest isPortugal with 0.39.

0.22 to 0.24 0.28 to 0.3 0.34 to 0.36

0.24 to 0.26 0.3 to 0.32 0.36 to 0.38

0.26 to 0.28 0.32 to 0.34 0.38 to 0.4

Figure: Gini for EU-27. Lower means more equal. Source:www.wolframalpha.com.

Look at GINI a different way

0 5 10 15 20 25

0.25

0.30

0.35

0.40

rank

Giniindex

rank curve

Figure: Ranked plot of Gini coefficients.


Part II

Social Policy in the EU


Defining Social Policy

Social Policy

Social policies include the various measures to regulate the labour marketbut also measures to combat poverty and social exclusion, and to improveeducation, training, housing and health care.

Treaty of Rome lays the foundations:

1 Free movement of workers (Articles 48–51);

2 Improvement in working conditions and in standards of living (Articles117–128);

3 Equal opportunities for men and women (Article 119); and

4 The creation of the European Social Fund (Article 123).


EU Employment Strategy

To develop a co-ordinated strategy of the member states towardunemployment;The commitment to achieving a high level of employment isrecognised as one of the key objectives of the EU;Employment is a matter of common concern;Member states and the EU were obliged to work together indeveloping a co-ordinated strategy towards employment;The ’mainstreaming’ of employment policy, which must be taken intoaccount in the formulation of all EU policies and strategies;Establishment of an Employment Committee to play a part in theseprocesses and serve as a forum for debateDecisions on employment policy are to be taken by a qualifiedmajority.

Looking good: Employment of women in the EU(27) rose from 53.7 percent in 2000 to 57.3 per cent in 2006, just above the Lisbon target of 57per cent for 2005, but still below the Lisbon target of 60 per cent for 2010.


Social Protection Expenditure

EU27 spent 26.9% of GDP on social protection. (Highest ratios in France,Sweden, Belgium). See Social protection in the European Union - Issuenumber 46/2008 Functions of social protection.

1 Sickness/health care: income maintenance and support in cash inconnection with physical or mental illness.

2 Family/children: support in cash or kind (except health care) inconnection with the costs of pregnancy.

3 Disability: income maintenance and support in cash or kind (excepthealth care) in connection with the inability of people with physical ormental disabilities to engage in economic and social activities.

4 Old age: income maintenance and support in cash or kind (excepthealth care) in connection with old age.

5 Survivors: income maintenance and support in cash or kind inconnection with the death of a family member (e.g. Survivor’spensions).


Social expenditure is big money.

2 46/2008 — Statistics in focus

27.2% of GDP was spent on social protection in 2005

In 2005, gross average expenditure on social protection (see methodological notes) accounted for 27.2% of GDP in the EU-27 countries (see Figure 1 and Table 1).

In 2005, the EU-27 countries with average or above-average ratios (27.2% or more) accounted for 39.6% of the EU population, the group with between 22.3% and 27.2% accounted for 30.0% of all EU inhabitants, and those spending between 17.4% and 22.3% of their GDP on social protection for 21.9%. Countries that spent less than 17.4% of

their GDP on social protection accounted for only 8.5% of the EU population.

The countries with the highest ratios - Sweden (32.0%), France (31.5%), Denmark (30.1%), Belgium (29.7%), Germany (29.4%), Austria (28.8%) and the Netherlands (28.2%) - spent more than twice as much (in relation to GDP) as the three countries with the lowest ratios, namely the Baltic countries: Latvia (12.4%), Estonia (12.5%) and Lithuania (13.2%).

There was a large difference between countries in terms of expenditure on social protection (in PPS* per capita)

If social protection expenditure is expressed in terms of per capita PPS (purchasing power standards), the differences between countries are more pronounced (see Figure 2).

Within the EU-27, Luxembourg had the highest expenditure in 2005 (12 946 PPS per capita)1, followed by Sweden and Denmark (more than 8 400 PPS per capita). The average value in these three countries is 8 times higher than in the three EU countries with the lowest expenditure, i.e. Romania (1 088 PPS per capita), Bulgaria and Latvia.

Of the countries outside EU-27, expenditure is highest in Norway (9 525 PPS), just below that of Luxembourg.

The disparities between countries are partly related to differing levels of wealth, but they also reflect differences in social protection systems, demographic trends, unemployment rates and other social, institutional and economic factors.

Figure 2: Expenditure on social protection in PPS* per capita, 2005

1088

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differences. PPS values are derived from purchasing power parities (PPPs), which are obtained as weighted averages of relative price ratios in respect of a homogeneous basket of goods and services, comparable and representative for each Member State.

** Data for Portugal refers to 2004 Source: Eurostat-ESSPROS

1 Luxembourg is a special case in that a considerable proportion of benefits are paid to people living outside the country (primarily

expenditure on health care, pensions and family benefits). If this particular feature is left out of the calculation, expenditure falls to approximately 10 902 PPS per capita.

Figure: % Overall social expenditure in the EU-27


Breakdown of social expenditure in the EU

Statistics in focus — 46/2008 3

Social protection expenditure as a percentage of GDP has remain stable since 2003 Looking at the EU-15 countries as a whole (for which data is available dating back to 1990), social protection expenditure as a percentage of GDP fell to 27.0% by 2000 after peaking at 28.7% in 1993. From 2001 to 2003, this ratio rose continuously to reach 27.8% in 2005 (see Table 1). However, social protection expenditure as a percentage of GDP has remained stable in the EA-13, as well as in the EU-15 and the EU-25 since 2003. This stability seems to be due to the difference between countries such as Germany, Austria, Poland and the Czech Republic on the one hand, where social protection expenditure as a percentage of GDP fell between 2003 and 2005, and countries such as Belgium, Ireland, France, Italy and Spain on the other hand, where social expenditure as a percentage of GDP rose continuously from 2000.

Between 2000 and 2005, expenditure on social protection as a percentage of GDP in the EU-25 was about 0.4 percentage points lower than in the EU-15.

Social protection expenditure goes to areas that either are not particularly affected by the economic situation (such as health expenditure and pensions) or are in fact counter-cyclical (unemployment or social exclusion).

Since 2000, in countries which continued to show strong GDP growth (Estonia, Latvia, Lithuania, Poland, Slovenia and Slovakia), the share of social protection expenditure in GDP has decreased.

In 2005, out of the total EU-27 expenditure on social protection (see Figure 3), social benefits accounted for 96.2%, administration costs for 3.1% and other expenditure for 0.7%.

Table 1: Expenditure on social protection (as % of GDP) 2000 2001 2002 2003 2004 2005

EU 27 : : : : : 27.2EU 25 26.6 26.8 27.1 27.4 27.3 27.4 Figure 3: Structure of social protection expenditureEU 15 27.0 27.1 27.4 27.8 27.7 27.8 in EU-27, 2005EA 13 26.8 26.9 27.4 27.8 27.8 27.8BE 26.5 27.3 28.0 29.1 29.3 29.7BG : : : : : 16.1CZ 19.5 19.5 20.2 20.2 19.3 19.1DK 28.9 29.2 29.7 30.9 30.9 30.1DE 29.3 29.4 30.0 30.3 29.6 29.4EE 14.0 13.1 12.7 12.6 13.1 12.5IE 14.1 15.0 17.3 17.8 18.2 18.2EL 23.5 24.1 23.8 23.6 23.6 24.2ES 20.3 20.0 20.3 20.4 20.6 20.8FR 29.5 29.6 30.4 30.9 31.3 31.5IT 24.7 24.9 25.3 25.8 26.0 26.4CY 14.8 14.9 16.2 18.4 17.8 18.2LV 15.3 14.3 13.9 13.8 12.9 12.4LT 15.8 14.7 14.1 13.6 13.3 13.2LU 19.6 20.9 21.6 22.2 22.3 21.9HU 19.3 19.3 20.4 21.1 20.7 21.9MT 16.5 17.4 17.5 17.9 18.4 18.3NL 26.4 26.5 27.6 28.3 28.3 28.2AT 28.1 28.4 29.0 29.3 29.0 28.8PL 19.7 21.0 21.1 21.0 20.1 19.6PT 21.7 22.7 23.7 24.1 24.7 :RO 13.2 13.2 13.4 12.6 15.1 14.2SI 24.6 24.8 24.8 24.1 23.7 23.4SK 19.3 18.9 19.0 18.2 17.3 16.9FI 25.1 24.9 25.6 26.5 26.6 26.7SE 30.7 31.2 32.2 33.2 32.7 32.0UK 26.9 27.3 26.2 26.2 26.3 26.8IS 19.2 19.4 21.2 23.0 22.6 21.7NO 24.4 25.4 26.0 27.2 25.9 23.9CH 26.9 27.6 28.5 29.1 29.3 29.2

Survivors4.3%

Housing2.2%

Social exclusion

1.2%

Family/ Children

7.7%

Unemployment5.8%

Admin. costs3.1% Other

expenditure0.7%

Old age39.9%

Disability7.6%

Sickness/ Health care

27.5%

Social benefits 96.2%

* The ratio EU27, EU25, EU15 and EA13 for 2005 is calculated with the 2004 data for Portugal Source: Eurostat-ESSPROS

Growth rate in per capita expenditure at constant prices fell in 2005 Per capita social protection expenditure at constant prices has increased steadily since 2000: in the

EU-25 it increased by an average of 2.1% per annum over the period 2000-2005 (see Table 2).

Figure: Breakdown of social expenditure in the EU. Source: Eurostat


Social transfers matter for poverty removal, 2006

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Figure: Social transfers by country in the EU-27 as a % of GDP in each country.Source: Eurostat


Part III

Routes out of Inequality


BabiesRemember Solow

(Mathematica Example)

174

EUROPE’S DEMOGRAPHIC FUTURE: FACTS AND FIGURES ON CHALLENGES AND OPPORTUNITIES

Figure 9 shows the different patterns of fertility decline in Europe. The drop in fertility took place firstly in Northern and WesternEurope, and was followed by Southern Europe with almost a 10 year delay and with a 20 year delay for Central Europe. Despitethese time lags fertility in Southern and Central Europe is today lower than in Western and Northern Europe. This means that thevarious parts of the EU are basically following the same transition albeit with important phase differences.

1960 1970 1980 1990 2000

1960 1970 1980 1990 2000

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Figure 9 Fertility trends in the EU between 1960 and 2003

Source: Eurostat.* Level needed for the replacement of generations.

Total fertility rate, 1960-2003

Central Western Europe Central Eastern Europe

Central Northern Europe Central Southern Europe


Part 3 – GREEN PAPER ‘CONFRONTING DEMOGRAPHIC CHANGE: A NEW SOLIDARITY BETWEEN THE GENERATIONS’

Figure: Source: Eurostat 2008, Europe’s demographic future: Facts and figures,Policies


And again:

174


Figure 9 shows the different patterns of fertility decline in Europe. The drop in fertility took place firstly in Northern and WesternEurope, and was followed by Southern Europe with almost a 10 year delay and with a 20 year delay for Central Europe. Despitethese time lags fertility in Southern and Central Europe is today lower than in Western and Northern Europe. This means that thevarious parts of the EU are basically following the same transition albeit with important phase differences.

1960 1970 1980 1990 2000

1960 1970 1980 1990 2000

1960 1970 1980 1990 2000

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Figure 9 Fertility trends in the EU between 1960 and 2003

Source: Eurostat.* Level needed for the replacement of generations.

Total fertility rate, 1960-2003

Central Western Europe Central Eastern Europe

Central Northern Europe Central Southern Europe


Part 3 – GREEN PAPER ‘CONFRONTING DEMOGRAPHIC CHANGE: A NEW SOLIDARITY BETWEEN THE GENERATIONS’

Figure: Source: Eurostat 2008, Europe’s demographic future: Facts and figures,Policies


Important trends

1 Gender Equality and Family situation

2 Ageing and the Labour Market

3 Education, R&D, Productivity

4 Migration & Integration

5 Sustainability of Public Finances and Social Protection

See: Economic Policy Committee and European Commission (2006), ‘Theimpact of ageing on public expenditure: projections for the EU-25 MemberStates on pensions, health care, long-term care, education andunemployment transfers (2004-50)’ in European Economy Reports andStudies, No1.


Education

“The race between technology and education” determines incomeinequality.Idea: increase supply of highly educated workers, reduce income inequalityover time.See Claudia Goldin and Lawrence Katz The Race between Education andTechnology, Harvard University Press, 2008


Public Service Provision

Discuss in Class

Raising and indexing to inflation the minimum wage, enhancing EarnedIncome Tax Credits, and expanding and improving public services ought tobe our top priorities for boosting the incomes and living standards of Irishcitizens in the lower half of the income distribution


Part IV

The CAP and Inequality


The CAP

1 Initially a price support mechanism

2 Mansholt Plan (1968); Series of reforms 1970’s and 1980’s

3 MacSharry reforms & Agenda 2000, Fischler reforms

Rural development measures 2007-2013.

1 Competitiveness

2 Land Management

3 Wider rural development

4 Training and skills


Spending by product group, 2007

arablesugarolive oilother veg.productswinemilkbeefother animal productsSerie 9

arablesugarolive oilother veg.productswinemilkbeefother animal products

Dati insufficienti per un diagramma.Il riquadro è troppo piccolo per tracciare il diagramma.arablesugarolive oilother veg.productswinemilkbeefother animal products

!

Figure: Spending by product group, 2007


CAP changes after 2013Biggest.Row.Ever.

Increased co-financing by member states

Making regionalisation mandatory;

Increased compulsory modulation;

An end to milk quotas;

Improved management of risk;

De-gressivity of direct payments (a fixed percentage decrease over aspecified interval of time);

Ceilings/caps on transfers to individual farms, and cancelling those offarms below a minimum size.

Continued promotion of biofuels

See Colman, D.‘The Common Agricultural policy’, in Artis, M. andNixson, F. (eds), The Economics of the European Union. Policy andAnalysis, 4th ed., Oxford University Press, 2007.


CAP & Enlargement

(See handout)


Next Time

Enlargement: Political Economy of accession to the EU, capital marketintegration.

Baldwin & Wyplosz, Chapter 19

* Estrin, S. and Holmes, P. Competition and Economic Integration inEurope, pp. 1–22. 337.142 EST

Smith, E. ‘EU Competition Policy Without Membership: Lessons forthe European Economic Area’, in Estrin, S. and Holmes, P.Competition and Economic Integration in Europe, pgs. 48–60.337.142 EST

Willem H. Buiter and Anne C. Sibert, ‘Eurozone Entry of New EUMember States from Central Europe: Should They? Could They?’


Economics of EU Integration

Lecture 9Enlargement: Political Economy of accession to the EU

Stephen Kinsella

Dept. Economics, KBSUniversity of [email protected]

November 17, 2009

Stephen Kinsella (University of Limerick) EC4333 November 17, 2009 1 / 30

From last time:

The Common Agricultural Policy.


Part I

The CAP and Inequality


The CAP

1 Initially a price support mechanism

2 Mansholt Plan (1968); Series of reforms 1970’s and 1980’s

3 MacSharry reforms & Agenda 2000, Fischler reforms

Rural development measures 2007-2013.

1 Competitiveness

2 Land Management

3 Wider rural development

4 Training and skills


Spending by product group, 2007

arablesugarolive oilother veg.productswinemilkbeefother animal productsSerie 9

arablesugarolive oilother veg.productswinemilkbeefother animal products

Dati insufficienti per un diagramma.Il riquadro è troppo piccolo per tracciare il diagramma.arablesugarolive oilother veg.productswinemilkbeefother animal products

!

Figure: Spending by product group, 2007


CAP changes after 2013Biggest.Row.Ever.

Increased co-financing by member states

Making regionalisation mandatory;

Increased compulsory modulation;

An end to milk quotas;

Improved management of risk;

De-gressivity of direct payments (a fixed percentage decrease over aspecified interval of time);

Ceilings/caps on transfers to individual farms, and cancelling those offarms below a minimum size.

Continued promotion of biofuels

See Colman, D.‘The Common Agricultural policy’, in Artis, M. andNixson, F. (eds), The Economics of the European Union. Policy andAnalysis, 4th ed., Oxford University Press, 2007.


CAP & Enlargement

(See handout)


Part II

Accession in the EU


Today

Impportant Questions

Has the widening of the EU been a success?

The benefits and costs of enlargement for1 New member states2 Existing (established) members of the EU3 The EU economy as a whole

EU enlargement and immigration policy

How many more countries will join?

Will enlargement prevent final economic union?

How many new states will join the Euro?

What of states that remain outside of the EU e.g. Norway,Switzerland, and Iceland?


Here comes the history bit.

Europe has added new members periodically

Six Main Waves of EU Enlargement

1973 (UK, Ireland and Denmark)

1981 (Greece)

1986 (Portugal and Spain)

1995 (Austria, Finland and Sweden)

2004 (Ten new countries)

2007 (Bulgaria and Romania)

See Senior-Nello (2008) and Burda and Wyplosz (1997) for details of thisenlargement.


Right now

Figure: EnlargementStephen Kinsella (University of Limerick) EC4333 November 17, 2009 11 / 30

Data

Figure: Convergence

More Data

1995 2000 2005

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�from 1991 to 2007 ; in percent per year �Figure: Inflation in EU, Ireland, Poland.


GDP vs UE: Estonia

Figure: GDP and Unemployment in Estonia


Problems with Convergence

Figure: GDP Convergence.

Criteria for Entry

Stability of political institutions guaranteeing democracy, the rule oflaw, human rights and respect for and protection of minorities

A fully functioning market economy that meets the standards requiredfor participation in the single market

Price Liberalisation: Moving away from state controlled prices toallow the price mechanism greater influence in allocating resources

Privatisation: Transfer of ownership, Development of private sectorcapital markets


Gains from joining the EU

Membership of the EU Single Market gives new entrants:

Trade Exploiting comparative advantage to increase trade.

Investment Free movement of capital – looking for the highest return.

FDI Inward investment to aid transformation of nationalinfrastructure – impact on a country’s LRAS / trend growth.

Competition More competition – a boost to labour productivity

Efficiency gains Dynamic efficiency gains from higher capital investmentand faster pace of innovation.


Gains for Accession Countries

Financial Support

Countries will be net recipients of income from

Common Agricultural Policy

EU Structural funds

Many regions have per capita incomes well below the 75% thresholdfor Objective 1 funding

92% of population of accession countries lives in regions with aGDP/head under 75% of the EU25 average. 61% of the populationlives in regions below 50%.

Much of the EU funding will help to finance investment


Macro advantages

Potential macroeconomic advantages

Reduced exchange rate volatility – many countries are keen to jointhe Euro to reduce exchange rate risk and benefit from lower interestrates.

Slovenia, Slovakia, Cyprus and Malta have joined the single currency

Slovenia – January 2007 / Cyprus and Malta – January 2008 /Slovakia – January 2009

Other countries do not meet the entry requirements or have chosen toremain outside – to retain monetary policy flexibility


Gains for existing EU Members

Export potential and exploitation of economies of scale

Foreign Investment and Incomes and Profits

More diverse European labour market

A cleaner environment

Reforms to the CAP (2013)

Spur to countries to reform their labour markets in the face of lowerlabour cost competition

Many countries are already engaging in tax competition


Useful ways to think about enlargement

Useful diagrams for this topic:

Trade diagrams – welfare effects from single market, exploitation ofcomparative advantage

AD-AS diagrams

Inward investment effects

Economic shocks within the enlarged EU economy

Economies of scale

Labour market diagrams e.g. impact of migration


Thinking a bit more about the sources of growth

The Sources of Growth

Productivity

Capital Stock

InventionInnovation

Technology

Labour Inputs

NaturalResources

EconomicGrowth

Fixed Capital

Infrastructure

Social Capital

Labour productivity

Total factor productivity

Labour Supply

Labour Utilisation

Human Capital

Figure: Sources of growth.Stephen Kinsella (University of Limerick) EC4333 November 17, 2009 23 / 30

Political Economy of Enlargement

Discuss. Who actually supported enlargement?

Reasons for support: Geographical proximity/Potential for Economicgain/Influence?

Limited Enlargement Inclusive EnlargementDrivers AT, FI, GC UK, DK, SWE

Brakemen BE, LUX, NE FR, GR, IRE, IT, PORT, SP


Failure of Treaty of Nice

“The starting point is that eastern enlargement can only be successfullycompleted if the interests of decisive players in present EU countries arerespected.”“On the one hand, enlargement is beneficial for important politicalfunctions of EU activities—particularly those of a public good character.On the other hand, there are concerns in regard to the private benefitsfrom integration largely associated with spending policies”See Heinemann (2002);Kohler (2004);


Who has the power in the EU?From Barr and Passarelli (2009)

J. Barr, F. Passarelli / Mathematical Social Sciences 57 (2009) 339–366 351

Fig. 2. EU15 stance toward EU (Spring 2003).

3.1.2. The EU 27

In regard to the 27 member countries, the first two principal components also account for roughly70% of the variance in the data. We again found a similar pattern with regard to the factors: thatfirst factor is the stance toward the EU on inter-national issues, while the second factor is the stancetoward the EU on domestic issues. The ideal points are presented in Fig. 3. Notice that because wenow include 27 countries rather than 15, the relative positions of the countries change. For example,whereas in the EU15 case, Germany and France have close positions, their relative positions becomefurther apart when we include all 27 countries. However, in both cases we find that Germany andFrance are located in the third quadrant of the graph. The reason for this spread has more to do withhow the relative positions of Portugal and Luxembourg change. In the EU15 case they are relatively‘‘far away’’ from Germany and France. However, when we include 27 countries, these two countriesare relatively closer to Germany and France than the much more Euro-enthusiastic countries such asSlovenia and Romania. As a result, there is a kind of ‘‘compression’’ of the moderate EU15 countrieswithin the EU27 landscape.

The newcomers from Eastern Europe tend to have generalized strong attitudes toward EUcentralization in domestic policy domains (high intra-national stance). A certain degree of diversity isassociated to the inter-national stance, probably due to mixed-feelings toward nationalism.

A rapid comparison of Figs. 2 and3 reveals that the ‘‘topology’’ of the coalitionswill change radicallyin the next few years, after enlargement. The ‘‘center’’ of the EU political space moves upwards, i.e., atleast for intra-national issues, the average propensity to centralize the decision making at Europeanlevel rises consistently. Some oldmembers that could be considered relative Euro-enthusiasts becomemoderate, if not Euro-skeptical after enlargement.19 We expect that countries that were determinant(pivotal) for some policy issues and irrelevant for some others will probably be in a very differentposition after the new members will have joined. Below, we provide quantitative evidence of thesechanges.

19 Observe that here we are talking about the relative attitudes of the countries toward the EU. The coordinates of the graphschange as a result of the PCA. Intuitively, the origin of the graph somehow reflects the barycentre of the political space.The position changes after the enlargement, do not imply that the citizens change their mind toward the EU because of theenlargement. It rather means that it is the center of the space to have shifted after enlargement.Since our analysis is intended to generate all the possible orderings of the players, then any possible issue of the political

space (on Hm−1) is considered. We do not have one specific point of the space that represents the status quo.

Figure: EU 15 Stance


When EU expands:

352 J. Barr, F. Passarelli / Mathematical Social Sciences 57 (2009) 339–366

Fig. 3. EU27 stance toward the EU (Spring 2003).

3.2. Measures of power

As discussed above, our objective is to evaluate the relative frequency that each Europeanmember

is pivotal within the Council of the Ministers, recognizing that the probabilities of the coalitions are

constrained by the preferences of the players. We present three different voting games to highlight

how the interaction of voting rules and preferences can alter the distribution of power.

1. The first is the pre-enlargement situation: 15 members and vote allocation more favorable to

the small and middle-size countries. We will refer to this scenario as pre-Nice.2. The second scenario takes into account the enlargement of the EU by the 12 members and the

re-weighting agreed at Nice. This is what we call the post-Nice scenario. It has come into force as of

November 1st 2004.20

3. The third scenario is represented by the Lisbon Treaty (LT): in which the old weighted voting

system is substituted by a double majority, based on both population and number of countries.21

3.2.1. Pre-Nice – 15 MembersTable 1 shows the results for the Pre-Nice scenario. It reports the standard Shapley–Shubik index

(S–S), the normalized Banzhaf index (NBI) and the ideological index in the Owen–Shapley perspective

(O–S) presented above in Section 2.1.1. If we look at the O–S values, we see that the number of votes

is no longer a good predictor of power. Shifting from standard S–S and NBI indices to the ideological

O–S value, yields a concentration of power. This is due to zero-probability, assigned to a large number

of ideologically non-consistent coalitions.

20Changes in the vote allocation from the pre-Nice situation to post-Nice can be seen by comparing column two of Tables 1

and 2. In the Treaty of Nice, the qualified majority threshold was increased from 62 out of 87, to 250 out of 345.

The Treaty of Nice prescribed that bills be passed by the Council with two quotas: a majority of states, and at least 62%

of the total population of the Union. These additional conditions produce negligible effects on winning coalitions. There is

widespread consensus about this point and we verified it through simulations. Thus, we disregard in our analysis these, and

other complicating aspects of the EU decision making, such as amendments, abstentions etc.

21The doublemajority sets two conditions for the passage of a bill: (a) more than 55% ofmember states vote ‘‘yes’’; and (b) the

population of the countries who have voted ‘‘yes’’ represents at least 65% of the total population of the EU.

For a limited number of issues, unanimity has been kept. Moreover, in the LT, a sort of safeguard clause has been introduced.

For simplicity, we focus here on double majority.

Figure: EU27 Expands.Stephen Kinsella (University of Limerick) EC4333 November 17, 2009 27 / 30

Future prospects

Romania and Bulgaria (2007)

Turkey (2010?)

The Balkans (Croatia, Bosnia, Serbia, Macedonia, Albania)?

Belarus, Ukraine, Georgia?

North Africa?


Next Time

Location Effects, Regional and Industrial Policy.


* Puga, D., ‘European regional policy in light of recent locationtheories’, Journal of Economic Geography 2(4), October 2002:372-406

Puga, D. ‘The rise and fall of regional inequalities’, European

Economic Review 43(2), February 1999: 303-334.


References

Jason Barr and Francesco Passarelli. Who has the power in the eu?Mathematical Social Sciences, 57(1):339–366, 2009.

Michael Burda and Charles Wyplosz. Macroeconomics: A European Text.Oxford University Press, 2nd edition, 1997.

Friedrich Heinemann. The political economy of eu enlargement and thetreaty of nice. European Journal of Political Economy, 19(1):17–31,2002.

Wilhelm Kohler. Eastern enlargement of the EU: a comprehensive welfareassessment. Journal of Policy Modeling, 26(3):865–888, 2004.

Susan Senior-Nello. The European Union: Economics, Policies, and

History. McGraw-Hill, 2008.



Location Effects, Regional and Industrial Policy

Stephen Kinsella


November 17, 2009


Today

1 EU’s Regional disparities wrt factors of production

2 Location Theory

3 New Economic Geography

4 Policy implementation & future challenges


Part I

Regional Disparities


The Problem

1/4 of EU citizens live Objective 1 regions;

and so are eligible to receive assistance from Structural Funds

Not good. The criterion for eligibility is GDP/per capita below 75%of EU average.


Recall: Significant disparity in Regional unemployment

10 regions with highest unemployment rates had twice the EU averageunemployment rate.

Figure: caption


Europe’s Factors of Production

Natural Resources

Europe has many different types of natural resources.

The Northern European Plain has fertile soil called chernozem. Thisland is good for farming.

The Ruhr and Po Valleys have deposits of iron ore and coal.

Some parts of Europe have forests such as Norway and Sweden.

There are large deposits of oil on the floor of the North Sea.

Mountainous areas have mineral resources.

The countries of Europe have advanced farming techniques, high cropyields, and fertile soil called chernozem.


Environmental Issues

Several areas in Europe are facing severe pollution problems:

Black Forest - Acid Rain

Venice - Water Pollution

Rhine, Danube, and Seine Rivers - Water Pollution


Europe’s Factors of Production

Highly skilled but diverse and relatively immobile labour sources overall.(Beware, this is a crass generalisation). See Blanchard (2005).World class capital infrastructure, but average level conceals hugedisparities. (Tipperary vs. Aalborg). See Ottaviano and Puga (1997)


Part II

Location Theory


Location Theory

Location of factors of production in space

Economic development and underdevelopment is one aspect of theuneven spatial distribution of economic activities.

Why do spatial inequalities (population or income) exist?

Why do economic units choose to locate close to each other?

What are the consequences of being outside existing centres?


Basic Concepts

Median Location. Hotelling:

1 Assume even distribution of consumers,

2 Sheltering effect

3 Applicable to other market spaces, including political

4 Equilibrium outcome is not socially optimal


Concept of Industry Orientation

Transfer-Oriented. Material-Oriented—Materials are bulky,expensiveto transport, or weight-losing

Market-Oriented. Output uses a ubiquitous input (e.g. water) or isexpensive to transport (fragile, limited shelf life)

Input-Oriented. Labour/Electricity/Amenities


So-Called Weber Definitions

Ubiquities. Resource available everywhere.

Localized Materials. Resource available in specific locations

Pure Material. Entire weight enters product

Gross Material. Weight-losing material]

Material Index = weight of localized inputs/weight of final product


Spatial Margins of Profitability

Weber emphasizes minimum transport cost.

Could be extended to minimum total cost

But there may also be spatial variation in revenue!

Profitability (TR-TC) also varies over space


Part III

Comparative advantage and the new economicgeography


Ricardo’s Big Idea

Comparative Advantage

Nations specialise in sectors in which they have a comparative advantage.French→wine, Irish→bitterness, etc.

Problem with CA

Didn’t explain location/specialisation decision within a country.


One more Big Idea: Krugman (1991)

Why does manufacturing become concentrated in a few regions,leaving others relatively under-developed?

Three keys to convergence or divergence of regions

µ : share of nominal income spent on manufacturing

σ > 1 : elasticity of substitution among the products

τ < 1: an inverse index of transportation costs

Big paper in this area is Krugman (1991), which won PK the Nobel Prize.


Example

Wage convergence between two regions depending on the share ofmanufacturing labor force in region 1 and internal transportation costs .

• One example of wage convergence between two regions depending on the share of manufacturing labor force in region 1 and internal transportation costs (Krugman, 1991):

Figure: Wage convergence.Stephen Kinsella (University of Limerick) EC4333 November 17, 2009 18 / 30

Centripetal and Centrifugal Forces

Other Centripetal and Centrifugal Forces

Pecuniary and non-pecuniary externalities

Congestion

Knowledge spillovers

(Skilled) Labor pooling

Empirical evidence exists to back this up: The toughness of competition ina market significantly affects low-productivity plant exits, productivitydistribution (truncation from below) and (tighter) price bounds. Directlink to DELL case. See Hortacsu and Syverson (2007)


More Evidence

Figure: Specialisation by region/country


Krugman index of specialisationThis shows most EU nations becoming more specialised EU economies seem to bespecialising more in their comparative advantages

Figure: Krugman IndexStephen Kinsella (University of Limerick) EC4333 November 17, 2009 21 / 30

Agglomeration

When productive factors can cross borders (international orinter-regional) integration may have very different effects

Scale economies and trade costs generate forces that encouragegeographic clustering of economic activity.

“Overall clustering” = some areas with lots of economic activity,others empty ‘core-periphery’

“Sectoral clustering”s = each sector clusters in one region, but mostregions get a cluster

Agglomeration/Dispersion

Basic idea is that lowering trade costs affect both. Agglomeration forces.Tend to lead industry to cluster geographically Dispersion forces. Tent toencourage industry to disperse geographically


Agglomeration Forces

Many agglomeration forces

Technological spillovers (e.g. silicon valley)

Labour market pooling (e.g. City of London)

Demand linkages (a.k.a backward linkages)

Supply linkages (a.k.a foreward linkages)

NEG forces on demand and supply links since they are clearly affectedby economic integration (lower trade costs)


1 Many forces lead to a tendency of firms to avoid agglomerations ofeconomic activity

2 Rents and land prices

3 High cost of other non-traded services

4 Competition with other firms

5 The NEG focuses on the last one “local competition” since it isclearly related to trade costs

6 As trade costs fall, distance provides less protection from distantcompetitors


Handout


Part IV

3 policy objectives


Regional Policy

EU always had poor regions (Mezzogiorno, etc.)

much spending on poor EU regions, but very little by EU (pre 1986)

1973, Ireland (poor at the time joined);

1981, Greece joined but no major reorientation of EU spendingpriorities.

In 1986, Iberian enlargement shifted power in Council and spendingpriorities changed


Policy Objectives

1 Objective 1. (about 70% of structural spending).� spending on basic infrastructure and production subsidies in less

developed regions: regions with incomes less than 75% of the EUaverage.

� Nordic exceptions (low population density)� There are about 50 objective 1 regions; they have about 20% of the

EU population.2 Objective 2. (about 10% of structural spending).

� projects in regions whose economies are specialised in declining coalmining, fishing, steel production, etc.

� spending should support economic and social conversion� About 18

3 Objective 3 (about 10% of the funding).� measure to modernise national systems of training and employment

promotion.


Next TimeAlong with a recap, of course!

International Trade, Tariffs, and Globalization. The EU is the largesttrading bloc in the world. What are the effects one might expect from aeconomic entity as large as the EU changing its trade-tariff policies?


* Stiglitz, J.E., and Greenwald, B. Helping Infant Economies Grow:Foundations of Trade Policies for Developing Countries, AmericanEconomic Review, Papers and Proceedings, May 2006.

Shaikh, Anwar, Globalization and the Myth of Free Trade.(2003)Prepared for the Conference on Globalization and the Myths of FreeTrade, New School, NYC.


References

Olivier Blanchard. Macroeconomics. Prentice Hall, 4rth edition, 2005.

Ali Hortacsu and Chad Syverson. Cementing relationships: Verticalintegration, foreclosure, productivity, and prices. Journal of PoliticalEconomy, 115:250–301, 2007. URL http://ideas.repec.org/a/ucp/jpolec/v115y2007p250-301.html.

Paul Krugman. Increasing returns and economic geography. Journal ofPolitical Economy, 99(3):483, 1991. doi: 10.1086/261763. URLhttp://www.journals.uchicago.edu/doi/abs/10.1086/261763.

Gianmarco Ireo Paolo Ottaviano and Diego Puga. Agglomeration in theglobal economy: A survey of the ’new economic geography’. CEPRDiscussion Papers 1699, C.E.P.R. Discussion Papers, October 1997.URL http://ideas.repec.org/p/cpr/ceprdp/1699.html.


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