economic integration and growth jan fidrmuc brunel university
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Economic Integration and Growth
Jan Fidrmuc
Brunel University
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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.
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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)
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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
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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.
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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*
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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.
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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*
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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
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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
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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
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Spain and Portugal
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Ireland
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Greece