Broken Levees: Europe’s Answer to the Global Changes in the Division of Labour Richard E. Baldwin Professor of International Economics, Graduate Institute of International Studies, Geneva Munich, 5 May 2006

Access to new markets Market opening  new opportunities  adjustment. 2 broad types of adjustment: –#1. Cross-sector specialisation (North-South). –#2. Within-sector specialisation & scale economies. Pains & Gains from trade. –Winners win more than the losers lose, but … Adjustment more difficult politically for #1 –Higher ratio of pains/gains.

New markets Former Soviet bloc nations. India & China. Look at size & how different.

10 New Member States

China & India China India

EU export pattern Industrial nations Asia Non EU15 Europe

Opportunities on Production Side

“Unbundling” Old days: ‘national systems’ –Skilled & unskilled labour + capital, management & technology. Cost of moving people, goods & ideas  –People , goods , ideas . New Century way: fragment production. –European technology & managers re-bundled with labour & capital in Central Europe, Asia. –Trade in productive factors.

Pains & gains Old days: Bundle  artificial reward to labour, capital and technology. Unbundling  winners & losers, but winners win more than losers lose. Wages of unskilled labour especially cheap in China & Central Europe. –Low productivity but even lower wages. … but, shortage of other talents. Potential for mutually beneficial exchange.

Europe’s answer Europe’s companies: responded well. Europe’s governments: responded badly.

Economic malaise Unbundling: Europe’s low & medium skilled workers were overpriced. –High productivity, but higher wages. Implied: –1. Price adjustment (relative wages fall) –2. Quantity adjustment (unemployment)

Winners & Losers

Government failure Mass unemployment: –Short-run vs permanent. –Tax burdens, disincentives, social exclusion. Traffic jam: –Insiders vs Outsiders. –Failure to see big picture, what Europe could be.

Passing Parade Parable

End Thank you for listening.

EU manufactures trade share

World: Very Regional