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)

ng)ky*

k*k0

Io

Do

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.

CE

D

B

k

f(k)

sf(k)

n+g)k

k’

f(k)’

A

sf(k)’

yc

y’

Induced capital formation effect, i.e. medium-run growth bonus

Allocation effecty*

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