SINGLE EUROPEAN MARKET 2 REF: SEM 2 nov08

Introduction This lecture will build on the introduction to the SEM ( or the internal market), and consider –The European airline industry –Further evaluation of the SEM programme –The growth effects of the SEM

Example: The Airline industry and the single market Europes airline industry liberalised Aims included: –increase competition –benefit consumers –make EU airlines more cost competitive in global terms See article and questions

Pre-liberalisation High fares High barriers to entry Limited number of airlines on a route Post-liberalisation Lower fares available Greater consumer choice Easier for new airlines to compete on a route Airlines (Ryanair, Ireland) can now fly from one foreign country (UK) to another foreign country (France) Development of low cost carriers

European LCC routes 2000

European LCC routes 2006

Source: CAA Airport Statistics

Further evaluation of the SEM programme Employment & inflexible EU labour markets Market concentration & price convergence Is the EU more innovative? Is the EU more efficient? –See data for EU Commission 1996, which supports Cecchini Report estimates in medium term

Mergers & takeovers (or acquisitions) Part of the restructuring process following integration M&A activity is high in EU. Most M&A is mergers within member state. –about 55% domestic. –Remaining 45% split between: one is non-EU firm (24%), one firm was located in another EU nation (15%), counterpartys nationality was not identified (6%).

Distribution of M&A quite varied: –Large States: share M&As much lower than share of the EU GDP. –Italy,rance,Germany 36% of the M&As, 59% GDP. Except UK. –Small Staes have disproportionate high share of M&A Integration (relatively) largest changes in smallest states Source Baldwin & Wyplosz

UKs share relatively 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 vary between member states : M&A activity in maufacturing More recently most activity in service sector See Allen (1998) & European Economy 2001 –On SEM reading list

More specific areas Look at the service sector Example, see Pelkmans, ch7, Services market integration. & other text books Also, Pelkmans for –ch5, Product market integration (section5.4) –ch6, Product market integration (sec.6.6 &6.7) –ch8, Network industries

Growth (dynamic) effects of the SEM Weve seen common market theory can show us the possible effects of moving from a customs union to a common market –The SEM programme aimed to make a common market a reality Weve seen the SEM increases competition in Europe We now consider the growth effects of the SEM

Growth effects of the SEM So far static allocation effects have been considered Baldwin (1989) argued dynamic gains may be 5 times greater than those in the Cecchini Report –Change rate at which new F of P (mainly K) accumulated, leading to growth of output/worker –Cecchini: liberalisation cant permanently raise growth rates –Baldwin: permanently raise growth rates

Basic diagram

Medium term Medium term growth bonus results in gains of up to 9% of GDP, compared to Cecchinis 6.5% –Eg.Spain……………………………………… …………………………………

European integration allocation effect Notes: raised efficiency improved investment climate raised investment in K raised output per person

Long term Long term growth bonus can be added to this, leading to the growth rate being percentage points higher. –Due to Technological progress (following investment in the medium term)

Long term growth More difficult to determine empirically in EU We can concentrate on medium term investment booms associated with European integration, like after Spain joined the EU Some States, such as Greece, have not benefited (compared to Spain, Portugal, and Ireland) due to poor macroeconomic management, a poor investment climate, and lack of supply side reform.

Question What opportunities and threats does the internal market pose for (a) British firms (b) Non-European firms? Also, see video & questions

Conclusions Cecchini underestimated SEM benefits according to Baldwin Overall, the SEM is one of the EUs most far reaching policies that has influenced many sectors of the economy The SEM had wide ranging political implications

Appendix: Theory

Medium & long term effects Capital (K) comprised of –Physical K –Human K –Knowledge K (technology)

Medium term –Increased output / person stops at a new higher level (as K / worker diminishes) Long term –Rate of growth (accumulation) permanently higher –Mainly accumulation of knowledge K (technological progress) as physical K suffers from diminishing returns

Medium term growth Analysis based on Solows growth model Assume –People save & invest a fixed % of income (s in diag.) –Constant % depreciation of K stock (d in diag.) –EU is a single, closed economy, with integrated K & L markets Equilibrium K/L* where inflow of K = depreciation of K This allows us to find output/worker (Y/L*) at point B

Inflow of K (investment) s(GDP/L) Depreciation / worker d (K/L) K/L* K/L Euro/L A

Inflow of K (investment) s(GDP/L) Depreciation / worker d (K/L) K/L* K/L Euro/L A B Output/worker GDP/L Y/L*

Integration has 2 stages Stage 1:Integration raises efficiency, thus raises output/worker –GDP/L shifts up to GDP/L1 –Y/L rises to Y/Lc at constant K/L*

Inflow of K (investment) s(GDP/L) Depreciation / worker d (K/L) K/L* K/L Euro/L A B Output/worker GDP/L Y/L*

Inflow of K (investment) s(GDP/L) Depreciation / worker d (K/L) K/L* K/L Euro/L A B Output/worker GDP/L Y/L* GDP/L 1 Y/Lc C

Stage 2: –As GDP/L shifts up to GDP/L1, this leads to the inflow of K (investment) curve shifting up, s(GDP/L) to s(GDP/L)1 –New equilibrium at point D, giving K/L1 –Output/ worker rises ( Y/Lc to Y/L1) as we move from point C to E (could take 10 years) C to E shows up as faster than normal growth, before growth returns to normal Medium term growth bonus –reflects improved efficiency stimulates I

Inflow of K (investment) s(GDP/L) Depreciation / worker d (K/L) K/L* K/L Euro/L A B Output/worker GDP/L Y/L* GDP/L 1 Y/Lc C s(GDP/L)1 D E Y/L1 K/L1

Depreciation / worker d (K/L) K/L* K/L Euro/L A B Y/L* GDP/L 1 Y/Lc C s(GDP/L)1 D E Y/L1 K/L1 Allocation effect Medium term growth bonus Induced K formation, resulting from integration

Long term growth More difficult to determine empirically in EU We concentrate on medium term investment booms associated with European integration, like after Spain joined the EU