Lectures on European Integration: Trade and Factor Market Integration. G. Di Bartolomeo

Transcription

1 Lectures on European Integration: Trade and Factor Market Integration G. Di Bartolomeo

2 Plan of these lectures Preface: Historical Remarks First Part: Basic Micro Tools Second Part: International trade benefits Third Part: Preferential trade effects Fourth Part: Scale Effects Fifth Part: Growth Effects

3 Degrees of economic integration Free trade area: no visible trade restriction between members Custom union: free trade area plus a common external tariff regime. Internal commodity market: Custom union plus free movement of goods (no invisible trade restriction) Common market: Internal commodity market plus free movement of service, capital, and labor Monetary union: Common market plus a common currency Economic union: Monetary union plus common economic policy

4 The Common Market after 2004

5 EU Trade Integration 1950: Schuman Plan (9 May) ECSC ( ) 1957: Treaty of Rome (I, G, F, NL, LUX, B) EEC+Euratom (1958) 1968: Custom Union completed (common external tariff) 1972: First enlargement (UK, D, IR) from 6 to 9 (1973) 1972: FTA with EFTA (AUT, IC, P, SW, CH) 1973: FTA with Norway & Finland 1981: Greece joins from 9 to : Spain & Portugal join from 10 to : Single European Act Common Market 1994: Treaty of the EU & EEA (EFTA+EEC) 1995: Fourth enlargement (AUT, FIN, SW) from 12 to : EMU+ECB (Monetary Union) Euro (2002) [Mon. Integration] 2004: Last enlargement from 15 to 27

6 First Part: Basic Micro Tools

7 Demand Curve Demand curve shows how much consumers would buy of a particular good at any particular price. It is based on optimisation exercise: would one more be worth price? Market demand is aggregated over all consumers demand curves horizontal sum.

8 Supply Curve Supply curve shows how much firms would offer to the market at a given price. Based on optimisation: would selling one more unit at price increase profit? Market supply is aggregated over all firms horizontal sum.

9 Consumer Surplus Since demand curve based on marginal utility, it can be used to show how consumers wellbeing (welfare) is affected by changes in the price. Gap between marginal utility of a unit and price paid shows surplus from being able to buy c* at p*. p* price Triangle is sum of all gaps between marginal utility and price paid (summed over total consumption) c* Demand curve quantity

10 Consumer Surplus If the price falls: price consumers obviously better off consumer surplus change quantifies this intuition. Consumer surplus rise, 2 parts: pay less for units consumed at old price; measure of this = area A: = price drop times old consumption p* p A B gain surplus on the new units consumed (those from c* to c ) measure of this = area B: Demand curve = sum of all new gaps between marginal utility and price. c* c quantity

11 Producer Surplus Since supply curve based on marginal cost, it can be used to show how producers well-being (welfare) is affected by changes in the price. Gap between marginal cost of a unit and price received shows surplus from being able to sell q* at p*. p* price Triangle is sum of all gaps between price received and marginal cost (summed over total production) q* quantity

12 Producer Surplus If the price rises: price producers obviously better off producer surplus change quantifies this intuition. Producer surplus rise, 2 parts: get more for units sold at old price; measure of this = area A: p p* A B Supply curve = price rise times old production gain surplus on the new units sold (those from q* to q ) measure of this = area B: = sum of all new gaps between marginal cost and price. q* q quantity

13 Supply & Demand in an OE Introduction to Open Economy Supply and Demand Analysis. Start with Import Demand Curve: this tells us how much a nation would import for any given domestic price presumes imports and domestic production are perfect substitutes imports equal gap between domestic consumption and domestic production.

14 Import Demand Curve (MD)

15 Import Supply Curve (MS)

16 MD-MS Diagram Diagram very useful easy identification of price and volume effects of a trade policy change. Welfare change likewise easy.

17 Second Part: International trade = benefits?

18 Trade Volume Effect and Border Price Effect Decomposing Home loss from price rise, P to P : Domestic price area C: home pays more for units imported at the old price: P area C is the size of this gain home loses from importing less at P : area E measures loss P C E MD marginal value of first lost unit is the height of the MD curve at M, but Home paid P for it before, so net loss is gap, P to MD adding up all the gaps gives area E. M M Home imports

19 Trade Volume Effect and Border Price Effect Systematic net welfare analysis using the price and quantity effects. Domestic price P Border price effect Trade volume effect Border price effect (area C), and the import volume effect (area E): P C E MD very useful in more complex diagrams. M M Home imports

20 Trade Volume Effect and Border Can do same for Foreign gain rise, P to P : foreign gains from getting a higher price for the goods it sold before at P (border price effect), area D and gains from selling more (trade volume effect), area F. Price Effect price P P D Border price effect Trade volume effect F X X XS F, MS H. exports

21 MD-MS + Open Economic Supply and Demand MD-MS diagram can be usefully teamed with open economy supply and demand diagram. Permits tracking domestic and international consequences of a trade policy change.

22 Tariff Analysis First step: determine how tariff changes prices and quantities: suppose tariff imposed equals T euros per unit. Tariff shifts MS curve up by T: exporters would need a domestic price that is T higher to offer the same exports (because they earn the domestic price minus T).

23 Tariff Analysis For example, how high would domestic price have to be in home for foreigners to offer to export M a to home? Answer is P a +T, so foreigners would see a price of P a.

24 Tariff Analysis New equilibrium in Home (MD=MS with T) is with P and M. Domestic price now differs from border price (price exporters receive). P vs P -T. Border price P FT P -T X =M XS=MS T X FT = M FT Foreign exports Domestic price P M MS with T MS M FT P FT MD Home imports

25 Positive Effects Domestic price rises. Border price falls. Imports fall. Can t see in diagram: domestic consumption falls domestic production rises foreign consumption rises foreign production falls. Could get this in diagram by adding open economy S & D diagram to right.

26 Welfare Effects

27 Welfare Effects: Home Drop in imports creates loss equal area C (Trade volume effect). Drop in border price creates gain equal to area B (Border price effect). Net effect on Home = -C+B. ALTERNATIVELY: private surplus change (sum of change in producer and consumer surplus) equal to minus A+C increase in tariff revenue equal to A+B same net effect, B-C (but less intuition).

28 Welfare Effects: Foreign Drop in exports creates loss equal area D: (Trade volume effect). Drop in border price creates loss equal to area B: (Border price effect). Net effect on Foreign = -D-B. ALTERNATIVELY: private surplus change (sum of change in producer and consumer surplus) equal to minus -D-B same net effect, B-C (but less intuition).

29 Welfare Effects: Useful Compression In cases of more complex policy changes useful to do home and foreign welfare changes in one diagram. MS-MD diagram allows this: home net welfare change is C+B foreign net welfare change is D-B world welfare change is D-C. Note: if home gains (-C+B>0) it is because it exploits foreigners by making them to pay part of the tariff (i.e. area B). Notice similarity with standard tax analysis.

30 Distributional Consequences: Home Home consumers lose, area E+C 2 +A+C 1 ; home producers gain E, home tariff revenue rises by A+B: net change = B-C 2 -C 1 (this equals B-C in left panel).

31 Third Part: Preferential trade effects

32 The EU as a Custom Union The Custom Union (completed in 1968) is open for its countries. European Economic Area. But it is a closed to the rest of the world (Common External Tariff).

33 The PTA Diagram

34 Discriminatory, Unilateral Liberalisation To build up to analysis of real-world policy changes (e.g. customs union): consider home removes T on imports only from partner. First step is to construct the new MS curve: the liberalization shifts up MS (as with MFN liberalization) but not as far since only on half of imports (shifts up MS to half way between MS (free trade) and MS (MFN T) but more complex, kinked MS curve with PTA.

35 Discriminatory, Unilateral Liberalisation Border price RoW Border price Partner Domestic price Home MS MFN MS PTA XS R XS P MS P P P P -T P -T T P a p* T 1 MD RoW Exports Partner Exports X R X R X P X P M M Home imports

36 Domestic Price and Border Price Changes Domestic price falls to P from P. Partner-based firms see border price rise, P -T to P. RoW firms see border price fall from P -T to P -T. Border price XS R Border price XS P Domestic price MS MFN MS PTA P -T P -T T P P -T P MS P MD X R X R X P X P M M RoW Exports Partner Exports Home imports

37 Quantity Changes: Supply Switching RoW exports fall. Partner exports rise more than RoW exports fall. Therefore domestic imports rise. Border price Border price Domestic price MS MFN XS R XS P MS PTA P P MS P P -T P -T T P -T MD X R X R X P X P M M RoW Exports Partner Exports Home imports

38 Trade Effects Trade Creation. Home production is now imported from partner (for the partner the price without tariff is higher, but for consumer is lower). (+) Trade Diversion. Home imported from the RoW now it is imported from partner (for the RoW the price is lower). (-)

39 Home s net change = A+B-C. Partner s net change = +D. RoW s net change = -E. Welfare Effects

40 Analysis of a Customs Union/FTA A Custom Union or a FTA involved a sequence of preferential liberalisations, but all of these were reciprocal (in example, both home and partner drop T on each other s exports.)

41 Analysis of a Customs Union Analysis is simply a matter of recombining results from the unilateral preferential case: in market for good 1, analysis is identical in market for good 2, home plays the role of partner and partner plays role of home.

42 Welfare Effects In market for good 1: home change = euros euros A+B-C 1 -C 2. In market for good 2 home change = D 1 +D 2. Note: D 1 =C 1. Net Home impact = P -T P D 2 XS P D C 1 2 C 1 P -T B A MD A+B-C 2. Partner impact identical. RoW loses. Exports X P X P X R X P M imports

43 Impact of Customs Union Formation

44 Customs Union vs. FTA FTA like CU but no Common External Tariff: opens door to tariff cheats : goods from RoW destined for home market enter via Partner if Partner has lower external tariff, called trade deflection solution is rules of origin meant to establish where a good was made: problems: difficult and expensive to administer, especially as world get more integrated rules often become vehicle for disguised protection. Despite the origin-problem in FTAs, almost all preferential trade arrangements in world are FTAs: CU s require some political integration: must agree on CET and how to change it, including antidumping duties, etc.

45 : The Two Non-Overlapping Circles Story IS NL B F D I L EEC-6 EFTA-7 N UK DK S FIN IR L P CH A E GR :

46 Preferential liberalisation in EEC and EFTA proceeded (EEC s customs union and EFTA s FTA completed by 1968). Two non-overlapping circles have been created. Discriminatory effects emerge, leading to new political pressures for EFTAs to join EEC (Trade diversion creates force for inclusion and as EEC enlarges, force for inclusion strengthens) When UK decides to apply for EEC (1961), 3 other EFTAns also change their minds (domino effect). In the mid-70s West Europe evolved into two concentric circles.

47 Evolution to Two Concentric Circles West Europe's Trade Arrangement in mid-1970s : IS IRL UK DK NL B D L N S EEC-9 FIN P F I CH A EFTA-7 E GR

48 WTO Rules A basic principle of the WTO/GATT is non-discrimination in application of tariffs. FTAs and CUs violate this principle. Article 24 permits FTAs and CUs subject to conditions: substantially all trade must be covered: (cannot pick and choose products). intra-bloc tariffs must go to zero within reasonable period if CU, the CET must not on average be higher than the external tariffs of the CU members were before (in EEC s CU this meant France and Italy lowered their tariffs, Benelux nations raised theirs (German tariffs were about at the average anyway).

49 EU-US Trade Disputes Foreign sales corporations The Airbus-Boeing dispute Genetically modified organisms The beef hormone dispute The banana dispute

50 Foreign sales corporations In 1971 the US Congress enacted the Domestic International Sales Corporation (DISC) Act whereby US firms could shelter part of their foreign income from tax. In 1976 the GATT ruled against the DISC system as acting like a prohibited export subsidy, and in 1981 proposed a formula for settling the dispute. In 1984 the US replaced the DISC system with the Foreign Sales Corporation (FSC) Act. In 1998 the WTO panel ruled that the FSCs acted as an export subsidy and violated GATT obligations. In 2000 the US Congress enacted the Extraterritorial Income Exclusion Act to replace the FSC system, but again in 2002 the WTO ruled against the reformed system, and entitled the EU to impose retaliatory measures. The EU waited for two years, but from March 2004 gradually began to apply countermeasures. In October 2004 Bush signed legislation to phase out the FSC scheme from 2005 and replace it with new corporate tax breaks. The European Commission intends to refer the issue back to the WTO.

51 The Airbus-Boeing dispute In October 2004 the EU and USA launched the biggest dispute to date in the WTO. Airbus $15 billion in illegal launch aid from France, Germany, Spain and the UK (1992 agreement between US and EU). In return the EU filed a counter-complaint: $15 billion (R&D). Differences over Airbus and Boeing had been dragging on for years.

52 Genetically modified organisms In the EU consumers are diffident about the use of genetically modified organisms (GMOs), and EC institutions generally reflect this attitude. In 1999 the US Government estimated that the loss to its producers from EU policy was in the order of $200 million a year just for lost corn sales. In 2003 the US took the case to the WTO (e.g. Agreement on Technical Barriers to Trade)

53 The beef hormone dispute In 1998 the WTO on imports of beef containing growthpromoting hormones (US and Canada) The EU: health risks, while the US no objection to the EU carrying out research, in the meantime the ban should be lifted. Both the US and Canada asked the WTO permission to retaliate if the ban were not lifted. At WTO. The EU: direct compensation to beef producers The US Government: an adequate labeling scheme would be an acceptable solution: made with artificial growth hormones vs. made in USA. In October 2003 a new EU hormones Directive entered into force (full scientific risk assessment). both the USA and Canada disagreed and stated that they would keep their sanctions. EU is currently following the WTO procedure against them.

54 The banana dispute Lomé Conventions (underdeveloped countries) Germany and the Netherlands and the ECJ. The main distributors of Latin American bananas contested the EU regime (GATT in 1993 and 1994). In 1997, the WTO Appellate Tribunal (US and five South American countries) asked for a regime change, but was ambiguous. The EU modified its regime, US considered the proposed changes cosmetic and insufficient (March) US unilateral sanctions (not only bananas) (April) WTO decision (April) the European Commission and US Government agreed on transition to a single tariff solution from Still dispute at WTO on the tariff between the producers.

55 Market Size Matters European leaders always viewed integration as compensating small size of European nations: implicit assumption: market size good for economic performance. Facts: integration associated with mergers, acquisitions, etc: in Europe and more generally, globalisation.

56 Facts M&A activity is high in EU. Much M&A is mergers within member state: about 5 per cent domestic remaining 45 per cent split between: one is non-eu firm (24 per cent), one firm was located in another EU nation (15 per cent) counterparty s nationality was not identified (6 per cent).

57 Facts Distribution of M&A quite varied: Big-four: share M&As much lower than share of the EU GDP I, F, D 36 per cent of the M&As, 59 per cent GDP (except UK) small members have disproportionate share of M&A.

58 Facts Why M&A mostly within EU? Why UK s share so large? non harmonised takeovers rules: some members have very restrictive takeover practices, makes M&As very difficult others, UK, very liberal rules. Lack of harmonisation means restructuring effects very impact by member states.

59 Economic Logic Verbally Liberalisation De-fragmentation Pro-competitive effect Industrial restructuring (M&A, etc.) RESULT: fewer, bigger, more efficient firms facing more effective competition from each other.

60 State Aid (Subsidies) Two immediate questions: as the number of firms falls, isn t there a tendency for the remaining firms to collude in order to keep prices high? since industrial restructuring can be politically painful, isn t there a danger that governments will try to keep money-losing firms in business via subsidies and other policies?. The answer to both questions is yes. Turn first to the economics of subsidies and EU s policy.

61 EU policies on State Aids 1957 Treaty of Rome bans state aid that provides firms with an unfair advantage and thus distorts competition. EU founders considered this so important that they empowered the Commission with enforcement.

62 EU Competition Policy To prevent anti-competitive behavior, EU policy focuses on two main axes. Antitrust and cartels. The Commission tries: to eliminate behaviours that restrict competition (e.g. price-fixing arrangements and cartels) to eliminate abusive behaviour by firms that have a dominant position. Merger control. The Commission seeks: to block mergers that would create firms that would dominate the market.

63 Growth Effects European leaders have long emphasised a different the pro-growth aspects of European integration. These operate in a way that is fundamentally different from the way allocation effects operate. They operate by changing the rate at which new factors of production mainly capital are accumulated, i.e. the name accumulation effects.

64 Verbal Logic of Growth Growth in income per worker requires more output per worker. Nation s labour force can produce more goods and services year after year only if they have more/better tools year after year: tools means capital broadly defined: physical capital (machines, etc.) human capital (skills, training, experience, etc.) knowledge capital (technology).

65 Verbal Logic of Growth ERGO, rate of output growth linked to rate of physical, human and knowledge capital accumulation. Most capital accumulation is intentional and it is called investment: thus: European integration affects growth mainly via its effect on investment in human capital, physical capital and knowledge capital.

66 Verbal Logic of Growth: Summary European integration (or any other policy) Allocation effect Improved efficiency Better investment climate More investment in machines, skills and/or technology Higher output per person. Medium run effects eventually peter out Growth returns to its long-run rate. Long-run effects raise long-run rate forever.

67 Some Facts European Growth Phases,

68 Some Facts Growth in the WWII Reconstruction Phase