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

2. Last Lecture Market Size and Scale Effects
Theory and Politics of European Integration Growth effects and capital market integration
Last Lecture
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 EU competition policy EU competency: 1st pillar
Theory and Politics of European Integration Growth effects and capital market integration
Last Lecture
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. Last Lecture EU Trade Policy Policy Country composition of trade
Theory and Politics of European Integration Growth effects and capital market integration
Last Lecture
EU Trade Policy Policy
Country composition of trade
Composition of goods on export and import side
EU Competencies in trade policies
Trade negotiations at WTO
Structure of MFN tariffs
Preferential trade agreements
Generalised System of Preferences

5. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
euros
price
Mark-up
Home market
After integration, each firm has (i) second market of same size and (ii) twice the number of competitors
Average cost curve
Demand curve BE E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

6. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
euros
price
Mark-up
Home market
Average cost curve
Demand curve BE
Competition effect: number of firms is 2n’, such that mark-up declines to A at given firm number. E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

7. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
euros
price
Mark-up
Home market
Market size effect: BE curve shifts outward to the right. At given number of firms (point 1) we have no equilibrium).
Average cost curve
Demand curve BE E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

8. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
euros
price
Mark-up
Home market
Smaller mark-up and higher competition reduces prices to pA. Below breakeven point for given number of firms. Industrial restructuring results in E’’ equilibrium number of firms.
Average cost curve
Demand curve BE E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

9. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
euros
price
Mark-up
Home market
Since each firm has a larger market in new equilibrium, average costs decline. Efficiency gain.
Average cost curve
Demand curve BE E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

10. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
euros
price
Mark-up
Home market
Average cost curve
Demand curve BE
Welfare gain: C. Consumer benefit from (i) lower prices, (ii) higher consumption. E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

11. Pro-competitive effect:
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Economic logic
Integration: no-trade-to-free-trade: BE curve shifts out (to point 1). (Larger market effect)
Defragmentation:
PRE typical firm has 100% sales at home, 0% abroad; POST: ,
Can’t see in diagram.
Pro-competitive effect:
Equilibrium moves from E’ to A: Firms losing money (below BE).
Pro-competitive effect = mark-up falls.
short-run price impact p’ to pA.

12. This lecture Growth effects Some facts on EU post-WWII growth
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
Capital market integration
Microeconomics of capital market integration

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

14. hence the name ‘accumulation effects’.
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’.

15. Growth in income per worker requires more output per worker
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.),
knowledge capital (technology).

16. Most capital accumulation is intentional and it is called investment.
Theory and Politics of European Integration Growth effects and capital market integration
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.

17. Verbal logic of growth: summary
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
→ 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

18. Neoclassical growth: The Solow diagram
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
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.

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

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

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

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

23. GDP/L s(GDP/L) d(K/L) Y/L* K/L* K/Lo Io Do The Solow diagram euros/L B
Theory and Politics of European Integration Growth effects and capital market integration
The Solow diagram A B
K/L
euros/L
GDP/L
s(GDP/L)
d(K/L)
Y/L*
K/L*
K/Lo Io Do
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. Can’t see in diagram.

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

25. 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
Induced capital formation
K/L*
K/L*’
K/L

26. 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
Induced capital formation
K/L*
K/L*’
K/L

27. 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
Integration induced investment rate rise
K/L*
K/L*’
K/L

28. 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
Long-term endogenous growth
K/L*
K/L =Knowledge/L

29. Long-term growth effects: Knowledge acculation
Theory and Politics of European Integration Growth effects and capital market integration
Long-term growth effects: Knowledge acculation
Integration increases market size
Larger market size is related to higher allocative efficiency and scale economies
Higher market size increases e.g. knowledge pool
High knowledge pool is related to higher rate of knowledge accumulation
Similar for higher allocative efficiency: higher returns to knowledge accumulation
Higher knowledge accumulation increases rate of technological progress
Higher rate of technological progress increases long-term (permanent) growth rate

30. 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
Long-term growth impact of integration
K/L*
K/L =Knowledge/L

31. 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
Long-term growth impact of integration
K/L*
K/L =Knowledge/L

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

33. Facts: European Growth Phases, 1890-1992
Theory and Politics of European Integration Growth effects and capital market integration
Facts: European Growth Phases,
Period
Real GDP
Real GDP per capita
Real GDP per hour
2.6
1.7
1.6
1.4
1.0
1.9
4.6
3.8
4.7
2.0
2.7
Whole Period
2.5

34. Facts: Growth in the WWII Reconstruction Phase.
Theory and Politics of European Integration Growth effects and capital market integration
Facts: Growth in the WWII Reconstruction Phase.
The Set-Back: (Pre-war year when GDP equalled that of 1945)
Back-on-Track Year (Year GDP attained highest pre-war level)
Reconstruction Growth (rate 1945 to col. 2 year)
Austria
1886
1951
15.2%
Belgium
1924
1948
6.0%
Denmark
1936
1946
13.5%
Finland
1938
1945
n.a.
France
1891
1949
19.0%
Germany
1908
Italy
1909
1950
11.2%
Netherlands
1912
1947
39.8%
Norway
1937
9.7%
Sweden
These nations grew during WWII
Switzerland UK

35. Theory and Politics of European Integration Growth effects and capital market integration
Facts: GDP per capita & Rankings, 1950 and (1990 international dollars).
1950 GDP (1990 $)
European Rank 1950
Change in Rank
GDP Growth Rate
EEC average
4,825
8.0
+ 1.2
4.2
EFTA average
6,835
3.6
-1.4
3.0
France
5,221
7.0
+ 2
4.0
Germany
4,281
9.0
+ 5
5.0
Italy
3,425
13.0
4.9 UK
6,847
2.0 -5
2.4

36. Theory and Politics of European Integration Growth effects and capital market integration
1950 GDP (1990 $)
European Rank 1950
Change in Rank
GDP Growth Rate
EEC average
4,825
8.0
+ 1.2
4.2
Netherlands
5,850 5 -1
3.4
Belgium
5,346 6 -2
3.5
France
5,221 7
+ 2
4.0
Germany
4,281 9
+ 5
5.0
Italy
3,425 13
4.9
EFTA average
6,835
3.6
-1.4
3.0
Switzerland
8,939 1
3.1 UK
6,847 2 -5
2.4
Sweden
6,738 3
+ 1
Denmark
6,683 4
Norway
4,969 8 -4
3.2
Finland
4,131 10
Austria
3,731 11
Others average
2,401
14.3
-0.3
5.2
Ireland
3,518 12 -3
Spain
2,397 14
5.8
Portugal
2,132 15
5.6
Greece
1,558 16
6.2
For Comparison USA
9,573
Japan
1,873

37. Theory and Politics of European Integration Growth effects and capital market integration
1950 GDP (1990 $)
European Rank 1950
Change in Rank
GDP Growth Rate
EEC average
4,825
8.0
+ 1.2
4.2
Netherlands
5,850 5 -1
3.4
Belgium
5,346 6 -2
3.5
France
5,221 7
+ 2
4.0
Germany
4,281 9
+ 5
5.0
Italy
3,425 13
4.9
EFTA average
6,835
3.6
-1.4
3.0
Switzerland
8,939 1
3.1 UK
6,847 2 -5
2.4
Sweden
6,738 3
+ 1
Denmark
6,683 4
Norway
4,969 8 -4
3.2
Finland
4,131 10
Austria
3,731 11
Others average
2,401
14.3
-0.3
5.2
Ireland
3,518 12 -3
Spain
2,397 14
5.8
Portugal
2,132 15
5.6
Greece
1,558 16
6.2
For Comparison USA
9,573
Japan
1,873

38. Empirical evidence: Are growth and integration related?
Theory and Politics of European Integration Growth effects and capital market integration
Empirical evidence: Are growth and integration related?
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 % for EU-15
GDP level effect of 2-4% for NMS-10
Germany: GDP level effect of %
e.g. Baas/Brücker/Hönekopp 2007; Baas/Brücker/Hauptmann 2009; Keuschnigg/Kohler 2002

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

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

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

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

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

44. Microeconomics of capital market integration
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

45. Microeconomics of capital market integration
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.

46. Microeconomics of capital market integration
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.

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

48. Merry X-mas and Happy New Year!
Theory and Politics of European Integration Integration of Labour Markets
NEXT LECTURE
January 12 (not December 15!), 16:00 hours
Merry X-mas and Happy New Year!