Economic Integration and Growth

1
Economic Integration and Growth

• Jan Fidrmuc
• Brunel University

2
Growth Effects of Integration

• Does European integration make countries growth
  faster?
• Allocation effect
• Integration removes barriers to movement of goods
  and factors of production ? more efficient
  allocation of resources ? higher output.
• Accumulation effect
• Integration ? greater economic and political
  stability ? investment less risky ? lower
  interest rates (lower risk premium) ? more
  investment ? higher growth and higher output per
  person.

3
Solow growth model

• Due to Solow (1956) and Swan (1956).
• Neoclassical production function with CTRS and
  labor-augmenting technology YF(K,AL)
• Constant savings rate s,
• Constant depreciation rate d,
• Constant population growth rate n
• Constant rate of technological progress g
• It is convenient to carry out the analysis by
  relating all variables to effective labor, AL
• kK/AL and yY/ALf(k)

4
Solow diagram
The inflow of new capital and how it varies with
K/AL
Outflow of capital per AL, constant depreciation
rate
Assume constant savings rate, s
5
Allocation Effect

• Integration allows resources to be allocated and
  used more efficiently
• Given amount of resources therefore produces more
  output
• f(k) curve shifts up and so does sf(k) curve
• Equilibrium value of k increases
• Output per worker rises
• Growth accelerates until the new equilibrium is
  reached.

6
Induced capital formation effect, i.e. medium-run
growth bonus
f(k)
E
y
C
f(k)
yc
Allocation effect
y
(dng)k
B
sf(k)
D
sf(k)
A
k
k
k
7
Accumulation Effect

• Integration makes investment in Europe more
  attractive and safer
• Risk premium and therefore interest rates fall
• Better institutional environment
• Increased political and economic stability
• Membership in the Eurozone
• Savings rate increases sf(k) curve moves up (but
  f(k) curve stays put), k rises
• Growth accelerates until the new equilibrium is
  reached.

8
Medium-run growth bonus
f(k)
D
Y/L
Y/L
(dng)k
B
sf(k)
C
sf(k)
A
k
k
k
9
Empirical Estimates

• Customs unions raise trade flows among members by
  around 50
• Rose (2000) monetary union, on average, doubles
  trade among members of union.
• Rose and Stanley (2005) meta-analysis, currency
  union raises trade by between 30 and 90
• Frankel and Rose (2002) 1 increase in trade is
  associated with 1/3 increase in per-capita
  income

10
Empirical Estimates

• Lejour, de Mooij and Nahuis (2001) CGEM model,
  effects of enlargement
• Gain from Association Agreements (i.e. except
  agriculture and food) 2.6 of GDP in the
  candidate countries and 0.1 in the EU
• Gain from full trade liberalization and customs
  union 2.5 in CEECs and 0 in the EU
• Removal of informal trade barriers use gravity
  model of trade to estimate tariff equivalent of
  formal informal trade barriers
• CEEC exports to EU will rise by 50-65, EU
  exports to CEEC by 51 overall exports will rise
  by 30-44 and 2, respectively
• GDP rises by 5.3 in CEECs and 0.1 in the EU

11
Empirical Estimates

• Baldwin, Francois and Portes (1997, Econ Policy)
• Assume enlargement will bring about 10 reduction
  in cost of trade
• Predict integration effects using CGEM
• Conservative scenario GDP increase by 1.5 in
  CEECs (CZ, SK, PL, HU, SI, BG, and RO) and 0.2
  in the EU15
• Optimistic scenario, allowing for a risk-premium
  effect (CEECs to have the same risk premium as
  Portugal) GDP gain 19 in CEECs and 0.2 in
  the EU15

12
Spain and Portugal
13
Ireland
14
Greece