Economic Integration I Lecture 4 PDF

Economic Integration I Lecture 4 The trade and specialisation effects of the EU Customs Union 1  Introduction ▪ EU CU started 1958/ completed 1968 (two years early) ▪ CU theory predicts ▪ increased trade between m...

Economic Integration I Lecture 4 The trade and specialisation effects of the EU Customs Union 1  Introduction ▪ EU CU started 1958/ completed 1968 (two years early) ▪ CU theory predicts ▪ increased trade between member countries ▪ increased specialisation in production ▪ a one-off increase in output & income as resources move to more efficient uses Two questions ▪ What effect did CU have on trade of member countries? ▪ How did CU affect industrial specialisation? 2 1 What effect did the CU have on the trade of the member countries? ▪ Rapid trade growth in EC 1958-72 ▪ between member countries +15% a year (by value) ▪ with non-member countries +8.5% a year ▪ compared with world trade growth +8.5% a year ▪ Hence share of members’ trade with each other rose, i.e. from 30% in 1958 to 44% in 1967 ▪ consistent with CU theory , but is it causal ? Other factors affecting trade? 3 Did trade grow fast because of the CU or other factors? ▪ To answer this requires a counter-factual experiment - ‘anti-monde’ which would have existed if the CU had not been formed ▪ E.g. a simple counter-factual is to extrapolate the pre-1958 trend forward ▪ Also should distinguish the source of any increased trade – trade creation or trade diversion 4 Share of imports in consumption % Actual share Trade Total creation imports Trend pre-CU extended Imports from RoWorld Trade diversion 0 CU year formed 5  Conclusions of empirical studies of EEC effect early studies on CU effect found ▪ substantial effect within-EEC trade in manufactures (+15%-30% by 1970) ▪ trade creation far greater than trade diversion (for manufactured goods) ▪ trade with rest of the world not harmed except on agriculture (faster growth in EC attracted more imports) 2004 study using more powerful techniques concluded that ▪ 19-26% of  EU trade 1960-2000 due to tariff cuts ▪ main factor (70%) was rising incomes 6 [Badinger & Breuss 2004 What has determined the rapid post-war growth of intra-EU trade? Review of World Economics]  Effect of EU entry on UK ▪ UK joined EU in 1973 - CU completed by 1977 ▪ One study* estimates CU effects by hypothetically re- imposing tariffs on UK trade with the EU (in a computable general equilibrium model) and found ▪ by 1985 trade with EU had increased mostly by TC ▪ TD small ▪ some external TC, because UK external tariffs cut ▪ main gain however from increased competition/ efficiency ▪ UK gain estimated at just +1.5% of value-added in manufacturing ▪ *Gasiorek, Smith and Venables (2002) 'The accession of the UK to the EC: a welfare analysis' Journal of Common Market Studies 40/3 September ppp425-447 7  Adjustment issues ▪ In 1958, widespread fears that CU formation might cause large job losses and widespread factory closures ▪ but few trade problems & safeguard clause(temoprary import restriction) rarely invoked – why? (a) Golden Age of fast economic growth and long transition period – little unemployment ❖ 1950-1973: nearly 5% , 1973-1993: 2% (b) specialisation process (discuss next) (c) many trade barriers remained (hence need for Single Market programme: next lecture) 8  2 impact on industrial specialisation ▪ Pre-1958 anticipated that the CU would lead to ▪ strong industries in certain countries increasingly dominating the European market ▪ each country different specialisations → inter-industry trade→ job losses in some industries & job gains in others ▪ But in general this did not happen ▪ Balassa (1975) compared bilateral trade patterns (e.g. French exports to Germany vs. German exports to France) ▪ they became more similar in the two periods studied (1958 to 1963, and 1963 to 1970) , not more different 9  Intra-industry trade (IIT) IIT = country simultaneously imports and exports products of the same industry (see Appendix 1 for measure) ▪ why do IIT occur? ▪ many products are branded and produced in a number of varieties ▪ this gives consumers more choice ▪ but more varieties add to costs/ reduce scale economies ▪ under ‘monopolistic competition’ market balances the trade off between more choice against more scale economies 10  IIT : example ▪ suppose France and Germany each produce 10 varieties for home consumption only ▪ forming a CU could ▪ generate intra-industry trade in all varieties ▪ give consumers more choice (20 varieties) ▪ without sacrificing economies of scale ? ▪ without disrupting employment ? ▪ more likely, however, monopolistic competition leads to ▪ fewer domestic varieties produced, each on larger scale & at lower cost ▪ consumers get more varieties consumed with lower prices ▪ ➔Illustration: Furniture Industry: sofas 11  Economies of scale in the sofa industry With high output, the overhead costs Cost (e.g. design, marketing) can be spread per over more sofas sofa Cost curve for a sofa producer average cost Number of sofas O produced per firm Suppose that the sofa industry is characterised by monopolistic competition: 12 many firms produce different brands, with scale economies Equilibrium in the sofa industry depends also on how strongly consumers value variety of choice Equilibrium when consumers have a strong preference for varieties: cost many firms/ varieties, but lower q for each variety, and thus high p and AC Equilibrium when consumers have a weak preference for varieties: E1 few firms/ varieties but high q , lower p p1 and AC E2 p2 average cost (AC) output per firm O q1 q2 13 A selection of firms in the sofa industry before trade V3 V2 Highly symmetrical: V1 Each firm produces the same quantity at the same average cost av cost it es rie va p A O q outpu t 14 Total No. of varieties increase with lower prices After Trade V3 V4 V5 V2 has closed down, but new V1 Varieties V4 and V5 are now Imported from foreign counties Remaining firms produce on av cost larger scale (q), from A to B due to exporting it es In the home market rie va Less domestic varieties , p But more foreign varieties A p’ B Consumers have more varieties in total and q outpu q’ t lower prices through 15 trade  Pre-CU partial specialisation C C o o u CU expected: complete specialisation u n n t t r r y y A Actual: within (intra)-industry specialisation B 16 Industry 1 Trade flows Industry 2  Conclusions Q1 What effect did the CU have on the trade of the member countries? ▪ Within EU trade expanded fast / mostly TC Q2 How did the CU affect industrial specialisation? ▪ Industries became more similar not, as anticipated, more different, due to intra-industry trade Was the new CU a ‘single market’? ▪ No, because there were many non-tariff barriers left: still a collection of national markets: next lecture 17  Reading Textbooks ▪ Senior Nello pp114-6 (3rd) pp123-25 (2nd) or Baldwin & Wyplosz pp175-6 or J Pelkmans (2006) European Integration (3rd Ed) pp84-87 or El-Agraa (9th ed) Chap 9 Measuring etc Further reading Badinger & Breuss (2004) ‘What has determined the rapid post-war growth of intra-EU trade?’ Review of World Economics Gasiorek, Smith and Venables (2002) 'The accession of the UK to the EC: a welfare analysis' Journal of Common Market Studies 40/3 September ppp425-447 Brülhart & Hine eds (1999) Intra-industry Trade and Adjustment: the European Experience 18  Appendix 1: Intra-industry trade ▪ Grubel-Lloyd index of IIT measures how similar a country’s export products are to its import products: ▪ 0% = completely different, 100% = identical ▪ Balassa (1975) found for 1958 to 1970 ▪ Italy 42% ➔ 59%; France 61% ➔ 73% ▪ IIT continued to expand in all countries except Italy from 1970 to 1990 (Sapir 1992) ▪ for France IIT 83% by 1990 ▪ ______________________________ ▪ For more detailed discussion see: ▪ http://www2.econ.uu.nl/users/marrewijk/pdf/marrewijk/Intra%20Industry%20Trade.pdf ▪ Balassa, B. 1975, "Trade creation and diversion in the European Common Market", in B. Balassa (ed.), European Economic Integration, North-Holland: Amsterdam. 19 Luxury Bags and their home countries 20