Theorie und Politik der Europäischen Integration

1. Theorie und Politik der Europäischen Integration Theory and Politics of European Integration Lecture 5 Growth effects and the integration of capital and labour markets Prof. Dr. Herbert Brücker

2. Last Lecture Theory and Politics of European Integration Growth effects and capital market integration • Market Size and Scale Effects • Monopoly, Duopoly and Breakeven-Comp Diagram • Integration in the BE-COMP Diagram • Larger Market Size • Falling Average Costs • Higher Competition • Falling Prices • Higher Demand • Industrial Restructuring • Problems: • Higher market power of firms • Mergers and acquisitions • Anti-competitive behaviour • State aid policies

3. Last Lecture Theory and Politics of European Integration Growth effects and capital market integration ... EU competition policy • EU competency: 1st pillar • Forms of anti-competitive behaviour • collusion • cartels (e.g. vitamin cartel) • territorial price discrimination (e.g. Nintendo, pharmaceuticals) • abuse of dominant market position (e.g. Microsoft) • Two policy areas: • merger control • state aid policy

4. This lecture Theory and Politics of European Integration Growth effects and capital market integration • Growth effects • Some facts on EU post-WWII growth • The neoclassical growth model (Solow-model) • Integration in the neoclassical growth model • Capital market integration • Microeconomics of capital market integration • Labour Market Integration • Microeconomics of labour market integration • Imperfect labour markets • Empirical evidence from Germany

5. Growth effects Theory and Politics of European Integration Growth effects and capital market integration • 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, • hence the name ‘accumulation effects’.

6. Verbal logic of growth Theory and Politics of European Integration Growth effects and capital market integration • 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).

7. Verbal logic of growth Theory and Politics of European Integration Growth effects and capital market integration • 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.

8. Verbal logic of growth: summary Theory and Politics of European Integration Growth effects and capital market integration • European integration (or any other policy) • → allocation effect • → improved efficiency • → new profitable investment opportunities • → more investment in machines, skills and/or technology • → higher output per person. • In neoclassical growth model medium run effects eventually peter out • Growth rate returns to its long-run rate • In endogenous growth models long run effects raise long-run rate of technological progress, and, hence, the growth rate of output, capital stock and consumption forever

9. Neoclassical growth: The Solow diagram Theory and Politics of European Integration Growth effects and capital market integration • Shows medium run growth effects in simple diagram • Key assumptions: • Saving rate is constant • Depreciation rate is constant • Exogenous technological progress • Constant returns to scale • To simplify, start with whole EU as a single, closed economy with fully integrated capital and labour markets and the same technology everywhere.

10. euros/L GDP/L Y/L* d(K/L) B s(GDP/L) A Io Do K/L K/Lo K/L* The Solow diagram Theory and Politics of European Integration Growth effects and capital market integration

11. euros/L GDP/L Y/L* d(K/L) B s(GDP/L) A Io Do K/L K/Lo K/L* The Solow diagram Theory and Politics of European Integration Growth effects and capital market integration GDP per worker increases with increasing capital endowment, but marginal returns to capital decline

12. euros/L GDP/L Y/L* d(K/L) B s(GDP/L) A Io Do K/L K/Lo K/L* The Solow diagram Theory and Politics of European Integration Growth effects and capital market integration Saving (investment) rate is constant, such that savings are a constant share of GDP per worker

13. euros/L GDP/L Y/L* d(K/L) B s(GDP/L) A Io Do K/L K/Lo K/L* The Solow diagram Theory and Politics of European Integration Growth effects and capital market integration constant depreciation rate involves that the capital stock increases before we achieve point A, but declines thereafter

14. euros/L GDP/L Y/L* d(K/L) B s(GDP/L) A Io Do K/L K/Lo K/L* The Solow diagram Theory and Politics of European Integration Growth effects and capital market integration Thus, the long-run dynamic equilibrium is achieved at point A. This is called “steady state”. The economy grows here only at the rate of the technological progress.

15. How does integration affect growth? Theory and Politics of European Integration Growth effects and capital market integration • Allocation effect via trade etc. • Capital accumulation effect as consequence of higher allocative efficiency • Knowledge accumulation, i.e. higher rate of technological progress, through higher allocative efficiency and market size?

16. Induced capital formation Theory and Politics of European Integration Growth effects and capital market integration Induced capital formation effect, i.e. medium-run growth bonus euros/L GDP/L’ E Y/L’ C GDP/L Y/Lc Allocation effect Y/L* d(K/L) B s(GDP/L)’ D Growth impact of a technological push or efficency gain from integration s(GDP/L) A K/L* K/L

17. Induced capital formation Theory and Politics of European Integration Growth effects and capital market integration Induced capital formation effect, i.e. medium-run growth bonus euros/L GDP/L’ E Y/L’ C GDP/L Y/Lc Allocation effect Y/L* d(K/L) B s(GDP/L)’ D s(GDP/L) A K/L* K/L

18. Integration induced investment rate rise Theory and Politics of European Integration Growth effects and capital market integration Medium-run growth bonus GDP/L D Y/L’ Y/L* d(K/L) B s’(GDP/L) C s(GDP/L) A K/L’ K/L* K/L

19. Long-term endogenous growth Theory and Politics of European Integration Growth effects and capital market integration euros/L GDP/L Y/L* s(GDP/L) A d(K/L) B K/L* K/L =Knowledge/L

20. Long-term growth impact of integration Theory and Politics of European Integration Growth effects and capital market integration euros/L GDP/L s’(GDP/L) Y/L* s(GDP/L) C A d(K/L) B K/L* K/L =Knowledge/L

21. Long-term growth impact of integration Theory and Politics of European Integration Growth effects and capital market integration euros/L Integration improves efficiency → improves investment climate → higher investment rate (s rises to s’) → faster growth (knowledge capital accumulates more rapidly) GDP/L s’(GDP/L) Y/L* s(GDP/L) C A d(K/L) B K/L* K/L =Knowledge/L

22. Empirical evidence: Are growth and integration related? Theory and Politics of European Integration Growth effects and capital market integration • Prima facie evidence • EEC countries grew at 4.2% p.a. 1950-73 • EFTA countries grew at 3.4% p.a. 1950-73 • Poor countries grew at 4.2% p.a. 1950-73

23. Facts: European Growth Phases, 1890-1992 Theory and Politics of European Integration Growth effects and capital market integration

24. Facts: Growth in the WWII Reconstruction Phase. Theory and Politics of European Integration Growth effects and capital market integration

25. Facts: GDP per capita & Rankings, 1950 and 1973 (1990 international dollars). Theory and Politics of European Integration Growth effects and capital market integration

26. Theory and Politics of European Integration Growth effects and capital market integration

27. Theory and Politics of European Integration Growth effects and capital market integration

28. Empirical evidence: Are growth and integration related? Theory and Politics of European Integration Growth effects and capital market integration • Econometric evidence • Medium term growth bonus, but no long-run effects • Badinger 2005a, 2005b, • Coe/Moghadem 1993; Italianer 1994, Henrekson 1997 • EU Eastern enlargement: CGE simulation evidence • GDP level effect of 0.2-0.3% for EU-15 • GDP level effect of 2-4% for NMS-10 • Germany: GDP level effect of 0.4-0.6% • e.g. Baas/Brücker/Hönekopp 2007; Baas/Brücker/Hauptmann 2009; Keuschnigg/Kohler 2002

29. Capital Market Integration Theory and Politics of European Integration Growth effects and capital market integration

30. Microeconomics of capital market integration Theory and Politics of European Integration Growth effects and capital market integration

31. Microeconomics of capital market integration Theory and Politics of European Integration Growth effects and capital market integration Consider case where in initial situation capital per worker differs across countries. Interest rates differ as well.

32. Microeconomics of capital market integration Theory and Politics of European Integration Growth effects and capital market integration Integration implies that capital stock per worker converge, such that eventually capital stocks and interest rates are the same across countries.

33. Microeconomics of capital market integration Theory and Politics of European Integration Growth effects and capital market integration Home country (left axis) receives capital from foreign country (* denotes the foreign country), while foreign country (right axis) sends capital to home country.

34. Microeconomics of capital market integration Theory and Politics of European Integration Growth effects and capital market integration • ‘Native’ capital-owners in Home lose area ‘A’; • Home labour gains area A+ B; • Total economic impact on Home citizens equal to area B

35. Microeconomics of capital market integration Theory and Politics of European Integration Growth effects and capital market integration • Foreign capital still employed in Foreign gains F; • Foreign labour loses D+F; • total impact on Foreign-based factors is -D.

36. Microeconomics of capital market integration Theory and Politics of European Integration Growth effects and capital market integration • if we count the welfare of Foreign capital owners whose capital now works in Home (gains C+D), so overall Foreign welfare gain is C.

37. Microeconomics of capital market integration Theory and Politics of European Integration Growth effects and capital market integration Thus, net earnings increase in both countries, but labour loses in foreign and capital loses in home country.

38. The Integration of Labour Markets Theory and Politics of European Integration Integration of Labour Markets

39. The Integration of Labour Markets Theory and Politics of European Integration Integration of Labour Markets • Labour market integration • Institutions: Free movement of workers • The determinants and scale of migration • The self-selection and out-selection of migrants • The labour market effects of migration • Model with clearing labour markets • Model with wage rigidities • Adjustment of other markets • Empirical evidence • Estimation of a model for Germany • Estimation EU enlargement effects

40. Institutions Theory and Politics of European Integration Integration of Labour Markets • Free movement of workers one of four fundamental freedoms in Treaty of Rome • fixed in 1957, came into force 1968 • Service trade: posting of workers • ‘Equal treatment’: Incentives for welfare shopping? • Transitional periods in case of low-income applicants • Southern enlargement: 7 years, but expired before time • Eastern enlargement (‘2+3+2’ formula)

41. Eastern enlargement Theory and Politics of European Integration Integration of Labour Markets • Selective application of transitional arrangements for NMS-8 • Opening of labour markets in 2004: IE, UK, SWE • Opening of labour markets after 2006: ESP, FIN, FR, IT, GR, LX, NL, PT • Latecomers (May 1, 2011): AT, GER • Selective application of transitional arrangements for NMS-2 • Opening of labour markets: FIN, SWE, ESP • All other countries apply, even IE and UK • Germany will prolong beyond 2011 • But liberal conditions in IT • Selective application has resulted in migration diversion

42. The scale of migration Theory and Politics of European Integration Integration of Labour Markets • Theories of the migration decision • Migration is driven by wage differences (Hicks, 1932) • Migration as an investment in human resources (Sjaastadt, 1962) • Net present value of earnings difference (incl. costs) • Consideration of social and psychic costs • Employment opportunities (Harris/Todaro, 1970) • Network effects and chain migration (Massey, 1987) • Uncertainty, incomplete information and risk aversion (Burda, 1995) • Representative vs. heterogeneous agents • Stock vs. flow models (Brücker/Schröder, 2006)

43. The scale of migration: some facts Theory and Politics of European Integration Integration of Labour Markets • The income gap between the EU and the other countries on the European continent and its periphery is similar to that between the US and the sending countries in the Americas • Step by step migration from the Southern to the Northern EU countries was replaced by immigration from third-country nationals (Turkey, former Yugoslavia, Northern Africa and Middle East, Eastern Europe) • The average GDP per capita in PPP of the sending countries of migration in the EU-15 has declined from 60 per cent (1970) to 35 per cent (2005) • But: EU Eastern enlargement and financial crisis involved that today intra-EU migration accounts again for 50 per of total immigration in the EU-15 (and in the EU-27 as well)

44. The European income gap Theory and Politics of European Integration Integration of Labour Markets

45. The American income gap Theory and Politics of European Integration Integration of Labour Markets

46. The scale of migration: some facts Theory and Politics of European Integration Integration of Labour Markets • Net immigration rates in the EU are below those of the US, but tend to converge • Ireland, Spain, Italy and UK are today main destinations in EU • German immigration was well below EU average on 2000s, but immigration recovers in 2010 and presumably in 2011 • Eastern enlargement I: 1.4 million people migrated from NMS-8 into EU-15 between 2004-2010 • Eastern enlargement II: 1.6 million people from BU+RO migrated into EU-15 between 2004-10

47. The scale of migration: some facts Theory and Politics of European Integration Integration of Labour Markets • Migration diversion: 60 percent of the NMS-8 immigrants resided in DE and AT before enlargement, 70 percent moved to UK and IE after enlargement • 70 percent of NMS-2 migrants resided in DE and AT until 1995, 80 percent reside in ITA and ESP in 2010 • Related to selective application of transitional arrangements for free movement, but also other factors: high GDP growth rates in UK, IE, ESP and (less) ITA, English as an additional factor in case of UK and IE

48. Net migration rates, 1960 - 2005 Theory and Politics of European Integration Integration of Labour Markets

49. The skill composition of migrants Theory and Politics of European Integration Integration of Labour Markets • The education level of migrants and other abilities affect the labour market performance of migrants, their effects on native workers and on the fiscal balance of the welfare state • Most empirical studies find that the benefits from migration increase with skill level of immigrant population • via the labour market channel • via the welfare state channel

50. Is the skill composition relevant? Theory and Politics of European Integration Integration of Labour Markets • The labour market channel • The unemployment rate of migrants is about twice as high as that of natives • We can explain only a part of the difference in the labour market performance of migrants relative to natives by observable human capital characteristics, i.e. by education and work experience • Moreover, skilled immigrants replace less native workers than unskilled do • The welfare state channel • The fiscal benefits of the welfare state increase with the skill level of immigrants (Bonin et al., 1999; Brücker et al, 2002, Brücker et al. 2012).