ECONOMIC EFFECTS OF EU MEMBERSHIP Jacob A. Jordaan Utrecht University School of Economics j.a.jordaan@uu.nl Outline • Introduction • Overview of economic effects • Different stages of economic integration, different effects? • Decreasing “direct” effects, increasing “indirect” effects • ↑ Trade versus ↑ growth • Effects from economic enlargement • Foreign Direct Investment • Empirical papers with focus on Central and Eastern Europe • Drivers and effects of FDI • Integration and productivity growth Lecture 7 Economic Effects of the EU 2 Literature • Badinger, H., and Breuss, F. (2014) The quantitative effects of European post-war economic integration. In Jovanović, M.N. (ed.): International handbook of the economics of integration, Volume III. Edward Elgar Publishing, p. 285-315 (31 pages) • Jimborean, R. and Kelber, A. (2017) Foreign direct investment drivers and growth in central and Eastern Europe in the Aftermath of the 2007 global financial crisis. Comparative Economic Studies, vol. 59, p. 23-54 (32 pages) • Kutan, A.M. and Yigit, T.M. (2009) European integration, productivity growth and real convergence: Evidence from the new member states. Economic Systems, vol. 33, p. 127-137 (11 pages) Lecture 7 Economic Effects of the EU 3 Introduction • European Union massive social experiment • From start, growing level of enthiusiam and positivism on the positive effects of membership • Not surprising, as classical economic effects of integration are relatively easy to identify and understand • Majority are direct effects • Lower trade barriers and relate this to outpout/welfare, etc. • Standard trade theory fully in line with this • With increasing integration, effects become less “direct” and also more difficult to link directly to EU integration • Also trade theory is showing that we need to look at other elements • From static to dynamic effects Lecture 7 Economic Effects of the EU 4 Overview of effects • Starting from a Customs Union = Trade creation versus trade diversion • CU = lower trade restrictions between member countries, common restrictions to non-members • Static analysis, in line with Standard Trade Theory • Trade creation • lowering trade barriers between member countries, trade can increase • More trade leads to higher welfare • Trade diversion • Efficient non-member countries become more expensive due to tariff • Countries start to buy more products from less efficient member countries • Quantity of products less than would have been bought from efficient countries = decrease in welfare Lecture 7 Economic Effects of the EU 5 Lecture 7 Economic Effects of the EU 6 Trade Creation Trade Diversion Overall, trade creation outweighs trade diversion Lecture 7 Economic Effects of the EU 7 But the overall effects on GDP were modest Evaluation of single market • Is already becoming more complex • Traditional static analysis will not capture all the effects • Common market • Goods; Services; Capital; People • Lowering tariffs and NTBs • New trade theory shows us we need to include more issues • Scale economies, competition, innnovation, technology spillovers • This means that we need to include microeconomic changes • Other way to classify • Trade effects • Scale and accumulation • Location of production Lecture 7 Economic Effects of the EU 8 Some examples Lecture 7 Economic Effects of the EU 9 EMU • Economic and Monetary Union takes the level of integration one step further • Common currency lowers transaction costs, so trade should increase • Not always clear how to distinguish between effects in member and non-member countries • Effect may differ substantially between countries • Effect may also differ between industries Lecture 7 Economic Effects of the EU 10 Lecture 7 Economic Effects of the EU 11 Again, growth effects are much more limited EU enlargement • 2004 and 2007 • Large number of countries joined the EU • This was end result of lenghty process where countries had started to adopt the liberalisation policies of the EU • Result of enlargement • Growth population by 26% • Increase GDP by 16% • Decrease in GDP/Capita by 11% • New trade area larger than the US economy • Positive effects concentrated in the new member countries Lecture 7 Economic Effects of the EU 12 Lecture 7 Economic Effects of the EU 13 Foreign Direct Investment Multinational enterprises play key role in world economy 1. Investment made to acquire lasting interest in enterprises operating outside of the economy of the investor • 2. Purpose is to gain an effective voice in the management of the enterprise • Multinational enterprise / Transnational corporation • = parent enterprise and affiliates in other countries Lecture 7 Economic Effects of the EU 14 FDI and trade Lecture 7 Economic Effects of the EU 15 What explains FDI? • OLI paradigm • Ownership = a firm has market power given by unique and sustainable ownership-specific advantages in the servicing of (groups of) markets • Location = there is an advantage in locating production in another country rather than in the home country • Export versus production in another country • Prices of inputs, productivity, quality, proximity to market, transport linkages, etc. • Internalisation = there is an advantage from internalising the production in another country rather than operating via arms length linkages Lecture 7 Economic Effects of the EU 16 Types of FDI • Horizontal FDI: a firm establishes (part of) its activities in another country • Vertical FDI: firm breaks up the value chain of its production process and places part of the production process in another country Lecture 7 Economic Effects of the EU 17 CEE important location for FDI Lecture 7 Economic Effects of the EU 18 Lecture 7 Economic Effects of the EU 19 Impact FDI on host economy • Heavily researched topic • Main challenge: Counterfactual? • Impact areas • Capital investment • Trade • Employment • Local linkages • Technology • Last couple of decades emphasis on productivity spillovers Lecture 7 Economic Effects of the EU 20 Drivers and effects of FDI in CEE • Jimborean and Kelber (2017) • Look at FDI flows to CEE for the period 1993-2014 • What factors influence the location pattern of FDI? • New trade theory: What explains competitive advantage = where does the prodution take place = what is location process of firm • Variety of external and internal factors • What is the effect of the inflow of FDI? • Inward FDI should generate positive growth effect • May be period specific Lecture 7 Economic Effects of the EU 21 Impact of crises • FDI flows to CEE countries • Two possible negative effects • 2007: onset of financial crisis • 2011: euro area sovereign crisis • Crisis(07) = 1 for period 2007:Q2-2009:Q2 • Crisis(11) = 1 for period 2009:Q2-2011:Q4 Lecture 7 Economic Effects of the EU 22 Lecture 7 Economic Effects of the EU 23 Negative impact on FDI, which impacts negatively on economic performance of CEE countries; Good exampe of the existence of international spillover efect of crisis Determinants of FDI Lecture 7 Economic Effects of the EU 24 C = human capital, macroeconomic stability, infrastructure, market size, country risk profile, unit labour costs, trade openness, proximity to Western Europe, stage of integration in EU accession process, corporate taks system, world economic growth, global risk environment INST = quality of institutions REF = structural reforms EAmacro = euro area business cycle EAfin = euro area financing conditions + the 2 crisis dummies of 2007 and 2011 General to specific modelling approach Lecture 7 Economic Effects of the EU 25 Estimated effects Lecture 7 Economic Effects of the EU 26 - Variety of country-level and international factors - Important to understand relative importance - Country variability - Not always clear how to design most effective government policies - Mixture of national and EU level policies? Growth effects from FDI Lecture 7 Economic Effects of the EU 27 GDP = yearly GDP growth FDI = FDI inflows as % of GDP H = human capital INV = gross fixed capital formation as % of GDP Y0 = initial GDP A = additional variables 2007 & 2011 crisis Interaction between FDI and crisis Estimated growth effects Lecture 7 Economic Effects of the EU 28 Integration and productivity growth • Kutan and Yigit (2009) • Try to assess the drivers of labour producticity growth in the 8 CEE countries that joined the EU in 2004 • Use data for 1995-2006 • Why focus on productivity? • Economic growth consists of two main components • Increase quantity and quality of inputs • Subject to decreasing returns to scale • In long run, productivity growth the source of economic growth • Key issue: role of technology gap? Lecture 7 Economic Effects of the EU 29 Drivers of productivity Lecture 7 Economic Effects of the EU 30 Control variables (Z) - Exports - Imports - FDI - Human capital - Capital formation - R&D expenditures Absorptive capacity Total factor productivity Lecture 7 Economic Effects of the EU 31 International trade Lecture 7 Economic Effects of the EU 32 Investment Lecture 7 Economic Effects of the EU 33 Trade: Impact of 2004 Lecture 7 Economic Effects of the EU 34 Investment: impact of 2004 Lecture 7 Economic Effects of the EU 35 Research and development Lecture 7 Economic Effects of the EU 36 Lecture 7 Economic Effects of the EU 37 Some additional findings Lecture 7 Economic Effects of the EU 38 Technology distance and absorptive capacity Lecture 7 Economic Effects of the EU 39 Main points (1) • Economic effects EU: analysis in line with phase of integration • Classical analysis: Trade creation > trade diversion • ↑ integration = ↑ indirect effects • Direct effect trade on growth limited • Trade, scale and accumulation, location of production • Growing use of simulations and econometrics based predictions • In addition effects of enlargement • FDI plays key role • Increase in investment • Key role in international trade • Technologies Lecture 7 Economic Effects of the EU 40 Main points (2) • CEE countries • There is a variety of factors that influence FDI location processes • In line with findings for other countries, but also differences • Policy making at national and EU level required • FDI creates positive growth effects • Economic integration and productivity growth • Long run economic growth: productivity improvement key • National and international drivers of productivity • Technology gap between CEE and other parts of EU • Process may be changing Lecture 7 Economic Effects of the EU 41 Implications for CEE • CEE are benefitting from membership of EU • Increasing levels of exports and imports • Growing levels of inward FDI • Also key role of domestic investment! • Role of CEE in EU less clear • Multinational enterprises seem to focus in CEE on assembly style activities • Restrictions on levels of value added that are “placed” in CEE • This may have repercussions on further economic development Lecture 7 Economic Effects of the EU 42