Theorie und Politik der Europäischen Integration

1. Theorie und Politik der Europäischen Integration Theory and Politics of Eropean Integration Lecture 8 Growth effects and capital market integration Prof. Dr. Herbert Brücker

2. Theory and Politics of European Integration Growth effects and capital market integration Last Lecture • EU trade and … • Facts • Intra-EU trade • Extra-EU trade • Commodity composition of exports and imports • MFN tariff levels • Contingent Protection • EU External Trade Preferences • GSP • EU-Mediterranean Trade Area • CIS and Balkans • Former colonies • Non-regional PTA’s

3. Theory and Politics of European Integration Growth effects and capital market integration Last Lecture • … competition policies • EU competencies • 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) • Leftovers • merger control • state aid policy

4. Williamson diagram euros Demand curve P’ a b P=AC c AC’ C’ C Quantity Theory and Politics of European Integration Growth effects and capital market integration Merger control • Initially P=AC. • Merger implies lower AC to AC’, but raises the price to P’. • DCS=-a-b; ‘ripoff’ • DPS=+a+c • Net welfare = -b+c ; ambiguous, ‘efficiency defence’ • Laissez-faire (in US and increasingly in EU); if free entry then eventually P driven down to AC’. • As in BE-COMP diagram.

5. Theory and Politics of European Integration Growth effects and capital market integration State aid economics • Look at two cases: • Restructuring prevention. • Unfair competition.

6. Theory and Politics of European Integration Growth effects and capital market integration Restructuring prevention • Consider subsidies that prevent restructuring • Specifically, each governments make annual payments to all firms exactly equal to their losses • i.e. all 2n’ firms in Figure 6-9 analysis break even, but not new firms • Economy stays at point A • This changes who pays for the inefficiently small firms from consumers to taxpayers. Mark-up BE BEFT E’ 1 m' E” A mA COMP Number of firms n’ n” 2n’

7. Theory and Politics of European Integration Growth effects and capital market integration Restructuring prevention: size of benefit • Pre-integration: fixed costs = operating profit = area “a+b” • Post-integration: operating profit = b+c • ERGO: Breakeven subsidy = a-c • Net Benefit: b+c+a-c=a+b euros Price Mark-up COMP Demand curve BEFT E’ E’ p’ a A AC A pA pA A b c MC 2n’ Number of firms Total sales Sales per firm x’ C’ CA xA= 2CA/2n’

8. Theory and Politics of European Integration Growth effects and capital market integration Restructuring prevention: welfare impact • Change producer surplus = zero (profit is zero pre & post) • Change consumer surplus = a+d • Subsidy cost = a-c • Total impact = d+c euros Price Mark-up COMP Demand curve BEFT E’ E’ p’ a d A AC A pA pA A b c MC 2n’ Number of firms Total sales Sales per firm x’ C’ CA xA= 2CA/2n’

9. Theory and Politics of European Integration Growth effects and capital market integration Only some subsidise: unfair competition • If Foreign pays ‘break even’ subsidies to its firms • All restructuring forced on Home • 2n’ moves to n”, but all the exit is by Home firms • Unfair • Undermines political support for liberalisation

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

11. Theory and Politics of European Integration Growth effects and capital market integration This lecture • Growth effects … • Some facts on EU post-WWII growth • The neoclassical growth model (Solow-model) • Integration in the neoclassical growth model • … and capital market integration • microeconomics of capital market integration

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

13. Theory and Politics of European Integration Growth effects and capital market integration 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.) and • knowledge capital (technology). • 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.

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

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

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

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

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

19. Theory and Politics of European Integration Growth effects and capital market integration Neoclassical growth: The Solow diagram • Shows medium run growth effects in simple diagram • To simplify, start with whole EU as a single, closed economy with fully integrated capital and labour markets and the same technology everywhere.

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

21. Theory and Politics of European Integration Growth effects and capital market integration Induced capital formation 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

22. Theory and Politics of European Integration Growth effects and capital market integration Integration induced investment rate rise 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

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

24. Theory and Politics of European Integration Growth effects and capital market integration Long-term growth impact of 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

25. Theory and Politics of European Integration Growth effects and capital market integration Long-term growth impact of 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

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

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

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

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

30. Theory and Politics of European Integration Growth effects and capital market integration NEXT LECTURE • The Integration of European Labour Markets • Reading: Baldwin/Wyplosz (2006), 2006, Ch. 7 • Boeri, T./H. Brücker (2005), Why Are Europeans So Tough on Migrants?, Economic Policy, 44, 631-703. • December 11.