Economic Impact of EU Membership on Entrants: New Methods and Issues PDF
Preview Economic Impact of EU Membership on Entrants: New Methods and Issues
~EuCoOzN~OMIuC IMPACT OF EU MEMBERSHIP ON ENTRANTS Economic Impact of EU Membership on Entrants New Methods and Issues Edited by Richard E. Baldwin Graduate Institute of International Studies (GIIS). Geneva and CEPR and Aymo Brunetti State Secretariat for Economic Affairs. Berne and University of Basel. Switzerland Springer Science+Business Media, LLC A c.I.P. Catalogue record for this book is available from the Library of Congress. ISBN 978-1-4419-4927-1 ISBN 978-1-4757-3407-2 (eBook) DOl 10.1007/978-1-4757-3407-2 Printed on acid-free paper All Rights Reserved © 2001 Springer Science+Business Media New York Originally published by Kluwer Academic Publishers, Boston in 2001. Softcover reprint of the hardcover 1st edition 2001 No part of the material protected by this copyright notice may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording or by any information storage and retrieval system, without written permission from the copyright owner. TTAABBLLEE OOFF CCOONNTTEENNTTSS PPRREEFFAACCEE VvBii IINNTTRROODDUUCCTTIIOONN iIxX RRiicchhaarrdd EE BBaallddwwiinn,, AAyymmoo BBrruunneettttii PPAARRTT II:: CCGGEE SSTTUUDDIIEESS SSOORRTTIINNGG OOUUTT TTHHEE EEFFFFEECCTTSS OOFF SSWWIITTZZEERRLLAANNDD''SS AACCCCEESSSSIIOONN TTOO TTHHEE EEUU:: 1 AA SSIIMMUULLAATTIIOONN AANNAALLYYSSIISS JJeeaann--MMaarriiee GGrreetthheerr,, TToobbiiaass MMuulllleerr FFOORREEIIGGNN DDIIRREECCTT IINNVVEESSTTMMEENNTT IINN PPRROODDUUCCEERR SSEERRVVIICCEESS 2277 JJaammeess MMaarrkkuusseenn,, TThhoommaass FF.. 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Given the interesting results and the wealth of methods used in these studies we decided to organize a conference on the topic of 'The Economic Impact of EU Membership on Entrants: New Methods and Issues". The idea was to use the work on Switzerland as a case study for discussing modern approaches on how to assess the economic effects of joining an integration zone. This seemed to us to be a topic of considerable interest for the rising number of prospective EU-member countries. The response was very favourable with many eminent scholars agreeing to contribute. The conference took place in Lausanne, Switzerland in October 1999 and the papers submitted together with the discussions are published in this volume. We would like to acknowledge the financial support of the Swiss State Secretariat for Economic Affairs and to thank the University of Lausanne for providing the venue facilities for the conference. Many persons helped in the preparation of the conference and this volume but we would like to especially mention Marc Surchat who provided substantial input for the conference and Walter Brodmann who very efficiently reviewed and finalized the manuscript. The Editors RICHARD E. BALDWIN AND A YMO BRUNETTI THE ECONOMIC IMPACT OF EU MEMBERSHIP ON ENTRANTS: NEW METHODS AND ISSUES INTRODUCTION What a transformation Europe has witnessed in the past 15 years. A ruthless observer in 1985 could have described the European Economic Community as a glorified customs union held together by an irreproducible mix of idealism, pretension, agriculture subsidies and guilt. Just a decade and a half latter, the European Union has achieved a depth and vigour of regional economic integration that surpasses all contemporary and historical efforts and it seems intent on pursuing ever-deeper integration. At the same time, the EU economy has recovered some of the economic dynamism it enjoyed in the 1950s and 1960s, and this has created a political economic 'gravitational' force that is attracting a queue of applicants. Between 1985 and 1995, 6 new members joined the incumbent 9, and membership talks are underway with another dozen nations. Beyond this perhaps another 10 to 20 nations are contemplating EU applications. This volume focuses on the entrants rather than the EU. Specifically it centres on the issues surrounding the likely economic impact that EU membership has on joining nations, with the main emphasis on new issues and methods. Given the significantly greater level of economic integration that now exists in the EU, accession brings up a host of issues that either did not arise or were of secondary importance during earlier enlargement waves. For instance, EU membership now entails eventual membership in the monetary union. This raises a series of new issues such as interest rate convergence, exchange rate stability and the loss of sovereignty over monetary policy. Additionally, these macro issues interact with micro issues such as export performance, capital formation and foreign direct investment (FDI). Migration, unemployment and foreign direct investment are further issues that acquire a magnified importance for the prospective entrants. Lastly, the vast majority of prospective entrants are small nations and the EU is by now an economic superpower. This radical size difference poses a series of challenges for economists. About half the chapters in this volume focus on the Swiss case that constitutes, in many ways, a natural experiment. Switzerland, with its long history of European integration and its market orientation, provides the researcher with wealth of data that is missing for many of the other nations contemplating EU membership. The unique role of the Swiss franc in the international financial system also makes the EMU and macro issues central to Swiss concerns. Nevertheless, exchange rate issues and questions related to changes in the monetary independence of small European x RICHARD E. BALDWIN AND AYMO BRUNETTI nations contemplating EU membership have a wide relevance to all prospective entrants. 1. NEW WORK IS NEEDED While there is hardly a dearth of work on the economics of EU enlargement, a disproportionate share of this focuses on the EU rather than the entrants. While understandable -- it is naturally more attractive to write about the impact on the EU with its 370 million citizens than on an entrant with a population of 5-15 million - the fact that upwards of 20 nations are seeking accession suggests that more works on the entrants is now essential. Of course, the entrants differ widely. No single collection of studies could address all the important issues. This volume, therefore, focuses on issues that are likely to have importance for many entrants. These include: .:. EMU-related issues, such as: ;.. Macro-micro interactions ;.. Migration .:. TradelMicro Issues ;.. FDI ;.. Tax reforms, especially changes in the VAT ;.. Labour Market Issues .:. Small Economy Concerns There is no clear cut method of addressing such issues since the economics profession is a long way from the "grand unified theory" of economic activity. Instead, a range of methods is used. These included: .:. Computable general equilibrium models used to calculate the impact of microeconomic reforms -- both trade and tax policy -- on the general economy . •: . Structural macroeconomic models for forecasting the short and medium-term consequences of integration . •: . Sociological and discrete choice empirical models to predict demographic issues like immigration or factors that are important in the localisation of firms. 2. SUMMARY OF THE INNOVATIVE CONTRIBUTIONS The chapters in this volume advance the research frontier in several ways. Many of the studies adopt the computable general equilibrium (CGE) approach and here important progress is made. The papers consider innovative ways of including growth effects, location effects and labour market effects. They also explore the problems of CGE modelling when the regions used are of vastly different economic size. On the macro side, the chapters present several innovations mainly focusing on the budgetary, interest rate, exchange rate and monetary policy aspects of EU membership. Consider these in turn. INTRODUCTION xi 2.1. The CGE approach The European Commission has mainly used CGE models for estimating impacts of reforms. CGE models are sufficiently rich to capture many detailed aspects of the working of markets. They can also offer some insights about the distributions of benefits and costs among different groups of the population and different sectors. CGE models have also the ability to show precisely which reforms will bring along the most benefits, which gives valuable information whether such reforms should be undertaken independently of joining the ED. Given the importance of the CGE approach, almost half the chapters in this volume are concerned with such analysis. In the Handbook of International Economics, Baldwin and Venables (1995) classify the microeconomic effect of integration into 'allocation effects' (i.e. the classic static effects allowing for both perfect competition with constant returns and imperfect competition with increasing returns), 10cation effects' (i.e. the impact on the geographical allocation of economic activity), and 'accumulation effects' (i.e., growth effects stemming from the accumulation of technology, physical capital, or human capital). Recently, the research frontier of CGE analysis has been expanding mainly in the direction of location and accumulation effects, and the chapters in this volume contribute to both developments. 2.1.1. Dynamic aspects of integration in CGE models The dynamic aspects of CGE models -- especially issues concerning the impact of integration on national capital stocks and FDI -- is still an area in which a good deal of progress is needed. The chapters by Ji~ Markusen, Tom Rutherford and David Tarr, by Jean-Marie Grether and Tobias Muller and by Renger van Nieuwkoop and Andre Muller focus on this set of issues. Markusen, Rutherford and Tarr, which analyses the impact C?f FDI in producer services, concentrates on the Iiberalisation of imports of services in Russia and its impact on FDI and growth. The framework of this analysis is however sufficiently large so that the method could be applied to any country and any sector quite easily. The key to the result is the specification of the production function where imported services are an intermediary good complementary to other services. It is argued that by definition services provided by foreign firms consist mostly in managerial, financial, informational and technical services, which are intensive in skilled labour. Although they need a local presence, they are particular in the sense that they can not be supplied locally with the same quality, as they require an accumulated knowledge that is often lacking in developing countries. By liberalising the import of services, and thus allowing an almost infinite supply of skilled labour, countries encourage domestic and foreign direct investments, which are complimentary. This in turn stimulates economic growth and the welfare of most voters. The model shows that the impact on unskilled labour is non-linear and ambiguous. Furthermore, the impact on providers of local services, which are a substitute to imported services, can be negative for a while. However, with time the quality of services provided by local xii RICHARD E. BALDWIN AND AYMO BRUNETTI finns improves and becomes competitive with those provided by international finns. In fact, in a vintage model, local service providers who have the ability to acquire foreign technologies without loosing their prior investment gain immediately. The government' choices are clear between protecting local providers and services or promoting economic growth. The chapter by Grether and Muller is innovative in several ways. The key to growth effects in dynamic CGE model is to determine how integration affects the equilibrium capital stock in an economy. Most dynamic CGE models rely on very simple rules for determining the equilibrium physical capital stock and thus for detennining the medium-tenn growth effects that occur as the economy approaches its new equilibrium capital stock. Specifically, models either rely on a constant savings rate, or they assume that the capital stock adjusts to restore capital's reward to a 'normal' level (see Baldwin and Francois, 1999 for a more complete discussion). Grether and Milller go beyond this, introducing for the first time the Blanchard (1995) approach to intertemporally optimal savings behaviour. The key equation here relates an endogenous savings rate to the levels of two types of wealth --human capital and physical capital. While the details are complex, the result is that the authors are able to allow tax policy (e.g. the VAT rate) to influence savings and investment behaviour. This brings up the second innovation which is that they allow for changes in trade policy and fiscal policy to interact. The third important innovation concerns assumptions that are necessary to consider the impact of integration between a very small and very large area (CGE models intrinsically have difficulties with large size asymmetries). The final innovation concerns foreign assets. Grether and Milller include earnings from foreign investments and this allows them to show that the benefits of unlimited free movement of capital. Although these effects are quite hard to estimate, they have probably been so far quite underestimated. The ongoing revolution on the European capital market might be a first sign of such an effect. The application chosen by Grether and Milller is a CGE model designed to study the economic consequences of the EU-membership of Switzerland. The study allows for numerous aspects of integration, including the budgetary costs of joining the EU and the implications for the Swiss tax policy, potential immigration, a lowering of non-tariff barriers, the adoption of the common external tariff and of the common agricultural policy, and finally joining the EMU. Although this covers most of the reforms, the list is probably not comprehensive. Finally Grether and Milller propose to include earnings from foreign investments which allows them to show that the benefits of unlimited free movement of capital, although they are quite hard to estimate, have probably been so far quite underestimated. The ongoing revolution on the European capital market might be a first sign of such an effect. Van Nieuwkoop and Muller also present a CGE model to analyse the microeconomic benefits of integration. Their research builds on their existing models and they incorporate it into a global model. The most innovative aspect of their model is its focus on transportation issues. Specifically, they estimated more precisely the gains from the transit agreement between Switzerland and the EU, which is expected to lower transportation costs. They also analyse alternative ways
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