Economic Integration and Growth Jan Fidrmuc Brunel University

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.

Solow growth model Due to Solow (1956) and Swan (1956). Neoclassical production function with CTRS and labor-augmenting technology: Y=F(K,AL)  Constant savings rate: s,  Constant depreciation rate: ,  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: k=K/AL and y=Y/AL=f(k)

Solow diagram A B k f(k) sf(k)  n  g)k y* k*k0k0 IoIo DoDo Assume constant savings rate, s The inflow of new capital and how it varies with K/AL Outflow of capital per AL, constant depreciation rate

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.

C E D B k f(k) sf(k)  n+g)k k’ f(k)’ A sf(k)’ ycyc y’ Induced capital formation effect, i.e. medium-run growth bonus Allocation effect y* k*

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.

C D B k f(k) sf(k)  +n+g)k k’ A s’f(k) Y/L ’ Medium-run growth bonus Y/L* k*

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

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

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

Spain and Portugal

Ireland

Greece