Theorie und Politik der Europäischen Integration Prof. Dr. Herbert Brücker Lecture 5 Growth...

Theorie und Politik der Europäischen Integration

Prof. Dr. Herbert Brücker

Lecture 5

Growth effects and the integration ofcapital and labour markets

Theory and Politics of European Integration

Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker

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



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



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

• Labour Market Integration• Microeconomics of labour market integration• Imperfect labour markets• Empirical evidence from Germany



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’.



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).



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.



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



• 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.

Neoclassical growth: The Solow diagram



The Solow diagram

A

B

K/L

euros/L

GDP/L

s(GDP/L)

K/L)Y/L*

K/L*K/Lo

Io

Do



The Solow diagram

A

B

K/L

euros/L

GDP/L

s(GDP/L)

K/L)Y/L*

K/L*K/Lo

Io

Do

GDP per worker increases with increasing capital endowment, but marginal returns to capital decline



The Solow diagram

A

B

K/L

euros/L

GDP/L

s(GDP/L)

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



The Solow diagram

A

B

K/L

euros/L

GDP/L

s(GDP/L)

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



The Solow diagram

A

B

K/L

euros/L

GDP/L

s(GDP/L)

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.



Induced capital formation

CE

D

B

K/L

euros/L

GDP/L

s(GDP/L)

K/L)

GDP/L’

A

s(GDP/L)’

Y/LcY/L’

Induced capital formation effect, i.e. medium-run growth bonus

Allocation effectY/L*

K/L*

Growth impact of a technological push or efficency gain from integration



Induced capital formation

CE

D

B

K/L

euros/L

GDP/L

s(GDP/L)

K/L)

GDP/L’

A

s(GDP/L)’

Y/LcY/L’

Induced capital formation effect, i.e. medium-run growth bonus

Allocation effectY/L*

K/L*



C

D

B

K/L

GDP/L

s(GDP/L)

K/L)

K/L’

A

s’(GDP/L)

Y/L’

Medium-run growth bonus

Y/L*

K/L*

Integration induced investment rate rise



K/L =Knowledge/L

euros/LGDP/L

s(GDP/L)

K/L)

Y/L*

K/L*

B

A

Long-term endogenous growth



Long-term growth impact of integration

K/L =Knowledge/L

euros/L

GDP/L

s(GDP/L)

K/L)

Y/L*

K/L*

B

A

s’(GDP/L)

C



Long-term growth impact of integration

K/L =Knowledge/L

euros/L

GDP/L

s(GDP/L)

K/L)

Y/L*

K/L*

B

A

s’(GDP/L)

C

Integration improves efficiency → improves investment climate → higher investment rate (s rises to s’) → faster growth (knowledge capital accumulates more rapidly)



Empirical evidence: Are growth and integration related?

• Prima facie evidence• EEC countries grew at 4.2% p.a. 1950-73• EFTA countries grew at 3.4% p.a. 1950-73• Poor countries grew at 4.2% p.a. 1950-73



Facts: European Growth Phases, 1890-1992

Period Real GDP Real GDP per capita

Real GDP per hour

1890-1913 2.6 1.7 1.6

1913-1950 1.4 1.0 1.9

1950-1973 4.6 3.8 4.7

1973-1992 2.0 1.7 2.7

Whole Period

1890-1992 2.5 1.9 2.6



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 1951 13.5%

Italy 1909 1950 11.2%

Netherlands 1912 1947 39.8%

Norway 1937 1946 9.7%

Sweden These nations grew during WWII

Switzerland

UK



Facts: GDP per capita & Rankings, 1950 and 1973 (1990 international dollars).

1950 GDP (1990 $)

European Rank 1950

Change in Rank 1950-1973

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 + 2 4.9

UK 6,847 2.0 -5 2.4



1950 GDP (1990 $) European Rank 1950 Change in Rank 1950-1973

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 + 2 4.9

EFTA average 6,835 3.6 -1.4 3.0

Switzerland 8,939 1 0 3.1

UK 6,847 2 -5 2.4

Sweden 6,738 3 + 1 3.1

Denmark 6,683 4 + 1 3.1

Norway 4,969 8 -4 3.2

Finland 4,131 10 0 4.2

Austria 3,731 11 + 2 4.9

Others average 2,401 14.3 -0.3 5.2

Ireland 3,518 12 -3 3.1

Spain 2,397 14 + 1 5.8

Portugal 2,132 15 + 1 5.6

Greece 1,558 16 0 6.2

For Comparison USA 9,573 2.4

Japan 1,873 8.0



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 0.2-0.3% for EU-15• GDP level effect of 2-4% for NMS-10• Germany: GDP level effect of 0.4-0.6% • e.g. Baas/Brücker/Hönekopp 2007;

Baas/Brücker/Hauptmann 2009; Keuschnigg/Kohler 2002



Capital Market Integration



Microeconomics of capital market integration

MPK

Ko

ro

Ko+ K*oK*o

r*oMPK*

euros euros

A

K’Capital flow

r’r’




MPK

Ko

ro

Ko+ K*oK*o

r*oMPK*

euros euros

A

K’Capital flow

r’r’

Consider case where in initial situation capital per worker differs across countries. Interest rates differ as well.




MPK

Ko

ro

Ko+ K*oK*o

r*oMPK*

euros euros

A

K’Capital flow

r’r’

Integration implies that capital stock per worker converge, such that eventually capital stocks and interest rates are the same across countries.




MPK

Ko

ro

Ko+ K*oK*o

r*oMPK*

euros euros

A

K’Capital flow

r’r’

Home country (left axis) receives capital from foreign country (* denotes the foreign country), while foreign country (right axis) sends capital to home country.




• ‘Native’ capital-owners in Home lose area ‘A’;

• Home labour gains area A+ B;

• Total economic impact on Home citizens equal to area B

MPK

Ko

ro

Ko+ K*oK*o

r*oMPK*

euros euros

K’Capital flow

r’r’A B

C D

E

F




• Foreign capital still employed in Foreign gains F;

• Foreign labour loses D+F; • total impact on Foreign-based

factors is -D.

MPK

Ko

ro

Ko+ K*oK*o

r*oMPK*

euros euros

K’Capital flow

r’r’A B

C D

E

F




• 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.

MPK

Ko

ro

Ko+ K*oK*o

r*oMPK*

euros euros

K’Capital flow

r’r’A B

C D

E

F




MPK

Ko

ro

Ko+ K*oK*o

r*oMPK*

euros euros

A

K’Capital flow

r’r’

Thus, net earnings increase in both countries, but labour loses in foreign and capital loses in home country.


Theory and Politics of European Integration Integration of Labour Markets

The Integration of Labour Markets



The Integration of Labour Markets

• Labour market integration• Institutions: Free movement of workers• The determinants and scale of migration• The self-selection and out-selection of migrants• The labour market effects of migration

· Model with clearing labour markets· Model with wage rigidities· Adjustment of other markets

• Empirical evidence· Estimation of a model for Germany· Estimation EU enlargement effects



Institutions

• Free movement of workers one of four fundamental freedoms in Treaty of Rome• fixed in 1957, came into force 1968

• Service trade: posting of workers

• ‘Equal treatment’: Incentives for welfare shopping?

• Transitional periods in case of low-income applicants• Southern enlargement: 7 years, but expired before time• Eastern enlargement (‘2+3+2’ formula)



Eastern enlargement

• Selective application of transitional arrangements for NMS-8• Opening of labour markets in 2004: IE, UK, SWE• Opening of labour markets after 2006: ESP, FIN, FR, IT,

GR, LX, NL, PT• Still closed: AT, GER

• Selective application of transitional arrangements for NMS-2

• Opening of labour markets: FIN, SWE, ESP• All other countries apply, even IE and UK• But liberal conditions in IT

• Selective application has resulted in migration diversion



The scale of migration

• Theories of the migration decision• Migration is driven by wage differences (Hicks, 1932)• Migration as an investment in human resources

(Sjaastadt, 1962)· Net present value of earnings difference (incl. costs)· Consideration of social and psychic costs

• Employment opportunities (Harris/Todaro, 1970)• Network effects and chain migration (Massey, 1987)• Uncertainty, incomplete information and risk aversion

(Burda, 1995)• Representative vs. heterogeneous agents

· Stock vs. flow models (Brücker/Schröder, 2006)



The scale of migration: some facts

• The average GDP per capita in PPP of the sending countries of migration in the EU-15 has declined from 60 per cent (1970) to 35 per cent (2005)

• The income gap between the EU and the other countries on the European continent and its periphery is similar to that between the US and the sending countries in the Americas



The European income gap



The American income gap

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

0 100 200 300 400 500 600 700 800

population (millions)

GN

I per

cap

ita

(Atl

as M

eth

od

)

USA

Canada

Mexico

Southern America

Middle America and Carribean




• Net immigration rates in the EU are below those of the US, but tend to converge

• Two-thirds of the EU-migrants stem from non-EU countries with increasing tendency

• Per capita GDP level of sending countries has fallen from 65 per cent of EU-9 recipient countries in 1970 to 35 per cent in 2005

• Intra-EU and intra-OECD migration increases slightly• Ireland, Spain, Italy and UK are today main destinations in EU• Eastern enlargement I: 1 million people migrated from NMS-8

into EU-15 between 2003-07• Eastern enlargement II: 1.3 million people from BU+RO

migrated into EU-15 between 2003-07




• Migration diversion: 60 percent of the NMS-8 immigrants resided in DE and AT before enlargement, 70 percent moved to UK and IE after enlargement

• 70 percent of NMS-2 migrants resided in DE and AT until 1995, 80 percent reside in ITA and ESP in 2007

• Related to selective application of transitional arrangements for free movement, but also other factors: high GDP growth rates in UK, IE, ESP and (less) ITA, English as an additional factor in case of UK and IE



Net migration rates, 1960 - 2005

-4

-3

-2

-1

0

1

2

3

4

5

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

net

mig

rati

on

rat

e (p

er 1

000

per

son

s)

Northern America

EU-15

Northern Africa & Midlle East

South-Eastern EuropeCIS

NMS-12

Sub-Saharan Africa



Migration stocks in EU-15 by region of origin, 2006



The skill composition of migrants

• The education level of migrants and other abilities affect the labour market performance of migrants, their effects on native workers and on the fiscal balance of the welfare state

• Most empirical studies find that the benefits from migration increase with skill level of immigrant population• via the labour market channel• via the welfare state channel



Is the skill composition relevant?

• The labour market channel• The unemployment rate of migrants is about twice as

high as that of natives• We can explain almost all of the difference in the labour

market performance of migrants relative to natives by observable human capital characteristics, i.e. by education and work experience

• Moreover, skilled immigrants replace less native workers than unskilled do

• The welfare state channel• The fiscal benefits of the welfare state increase with the

skill level of immigrants (Bonin et al., 1999; Brücker et al, 2002).



The skill-selection of migrants

• The composition of with respect to observable skills and unobservable abilities is driven by immigration policies (out-selection) and economic incentives (self-selection)

• Self-selection: the Roy(1951)-Borjas(1987) model:• migrants are positive self-selected on observable skills if

relative returns to education are larger at destination relative to sending country

• migrants are positively self-selected on unobservable skills if inequality of earnings is larger at destination relative to sending country and vice versa

• Caveat: Fixed migration costs or migration costs which fall with education change conclusion (Chiswick, 1999; Brücker/Defoort, 2009; Grogger/Hanson, 2008)



Empirical evidence

• New data sets which distinguish immigrants in OECD countries from 200 sending countries by education levels facilitate empirical analysis (Docquier/Marfouk 2006; Defoort 2009)

• Key findings:• Skill-selective immigration policies increase skill-level of immigrant

population significantly (Belot/Hatton, 2008; Bertoli et al., 2009; Brücker/Defoort 2009; Grogger/Hanson, 2008).

• Ambiguous results for the wage premium and earnings inequality• Emigration rate among skilled population is about 2-3 times as

higher as that of unskilled population.• Econometric evidence: increasing the inequality of earnings in

destination country increases favorable self-selection (Belot/Hatton, 2008; Brücker/Defoort, 2009)

• Increasing the inequality of earnings in sending country increases favourable self-selection as well (Brücker/Defoort, 2009)



School enrolment rates

0

20

40

60

80

100

120

140

0 200 400 600 800 1000 1200 1400 1600 1800

Bevölkerung in Millionen Personen

Bru

tto

bild

un

gsp

arti

zip

atio

nsr

ate

EU-15

EU-15

NMS-12

NMS-12

Südost-Europa

Südost-Europa

GUS

GUS

Nordafrika, Mittlerer Osten

Nordafrika, Mittlerer Osten

Afrika südlich der Sahara

sekundäre Bildung

tertiäre Bildung

Afrika südlich der Sahara



Skill structure of migrant population

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

An

teil

de

r Q

ua

lifi

ka

tio

ns

gru

pp

e i

n P

roze

nt

Hochqualifizierte Mittelqualifzierte Geringqualifzierte

Datenquelle: Docquier und Marfuk (2007).



Skill-selection with respect to the home population

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

Kanada Australien USA GB Deutschland Frankreich

Mig

rati

on

sra

te d

er

Ho

ch

qu

ali

fizi

ert

en

/Mig

rati

on

sra

te d

er

Mit

tel-

un

d

Ge

rin

gq

ua

lifi

zie

rte

n



Skill-selection with respect to the home population

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

Kanada Australien USA GB Deutschland Frankreich

Mig

rati

on

sra

te d

er

Ho

ch

qu

ali

fizi

ert

en

/Mig

rati

on

sra

te d

er

Mit

tel-

un

d

Ge

rin

gq

ua

lifi

zie

rte

n

Calculation:

(smh/ sm

l)/(snh/ sn

l)



Impact on the labour market

• Standard model with fixed capital stock, clearing labour markets and no trade• labour loses in host country, benefits in sending countries• capital loses sending country, wins in host country• natives benefits in host country, lose in home country

• Models with unemployment• Ambiguous impact

• Models with capital stock adjustment• larger economic gains• neutral for aggregate wages and unemployment

• Models with trade• neutral in small open countries (FPI theorem)



Standard model of labour migration (like capital)

MPL

Lo

wo

Lo+ L*oL*o

w*oMPL*

euros euros

L’migration

w’w’A B

C D

E

F




MPL

Lo

wo

Lo+ L*oL*o

w*oMPL*

euros euros

L’migration

w’w’A B

C D

E

F

• Initial situation• Marginal product of labour at

destination higher than in sending country

• Hence, wage at destination higher than in sending country




MPL

Lo

wo

Lo+ L*oL*o

w*oMPL*

euros euros

L’migration

w’w’A B

C D

E

F

• Labour moves from sending country to destination country

• New labour endowments L’• Hence, marginal product of

labour are equal in case of perfect mobility

• Wage at destination falls and increases at sending region




MPL

Lo

wo

Lo+ L*oL*o

w*oMPL*

euros euros

L’migration

w’w’A B

C D

E

F

• Welfare analysis• Native labour force at

destination loses A• Native labour force in sending

country gain F• Migrants gain C+D




MPL

Lo

wo

Lo+ L*oL*o

w*oMPL*

euros euros

L’migration

w’w’A B

C D

E

F

• Welfare analysis (cont.)• Capital owners at destination

gain A+B• Capital owners at sending

country lose F+D• Net effect: B+C



A model with unemployment

Real wage SSc

LI

wo

uo

Employment

D

Real wage

SSc

L’

wo

Employment

D

D’

w’

uo

Lo Lo

u’



Other adjustment machanisms: capital stock adjustment

• incentives for domestic or international investment increases if labour supply increases

• capital-labour ratio remains eventually constant• hence, factor prices remain constant as well• empirical evidence: capital-output ratio and, hence,

productivity adjusted capital-labour ratio is constant over time (Kaldor, 1961)

· e.g. Western Germany: capital-output ratio has increased from 3.0 (1960) to 3.14 (1990)



Capital-output ratio in Western Germany



Other adjustment mechanisms: trade

• International goods prices depend not on domestic supply (small country assumption)

• Host countries imports after labour supply shock less labour intensive goods, exports less capital intensive goods (trade substitution)

• production share of labour intensive sector increases, production share of capital intensive sector declines (Rybczynski-effect)

• prices on goods markets remain constant• prices on factor prices remain constant (Factor Price

Insensitivity Theorem)• Large economies: picture changes if domestic supply

affects global supply curve and global goods prices



Labour market effects: empirical evidence

• Spatial correlation approach· Uses variance of foreigner share across regions· endogeneity problem addressed by natural experiments or

IV-estimation· Find no or very small impact: at immigration of 1% of labour

force decline wages by 0.1% and increases unemployment rate by 0.1%-point (Longhi et al., 2005, 2006)

• National level approach· Uses variance of migration share across education and

experience cells· Regression and structural models· Find both large wage effects (Borjas, 2003) (0.4%) and

small effects (0.1%) (Ottaviano/Peri, 2006; Brücker/Jahn, 2008)



Estimating the labour market effects: an example

• Analysis of the labour market effects of migration in an empirical model which considers wage rigidities, unemployment and capital stock adjustment (Brücker/Jahn, 2009)

• European unemployment is usually explained by relationship between wage setting, price setting and labour demand (Layard/Jackman/Nickell, 2005)

• Assumption of a wage setting curve: wages fall with increasing unemployment, albeit imperfectly

• Why imperfectly? Wage bargaining, efficiency wages, search theories etc.



Estimating the labour market effects (cont.)

• Labour demand: once wages are set, profit-maximizing firms hire workers until the wage equals the marginal product of labour (plus an imperfect competition surcharge)

• Capital stock adjust to labour demand shock, but not immediately

• We distinguish four education groups, eight groups of work experience and native and migrants (64 types of labour)

• Estimating the elasticity of the wage-setting curve, of the parameters of the production function and of the speed of capital stock adjustment enables us to solve the model




• Data base: German social security records (IAB Employment sample), 1980-2004

• Also possible to do for other countries depending on data quality



How flexible is the German labour market?Elasticities of wage-setting curves by education and work experience




• Four scenarios:• 1 % immigration of labour force: high skilled only• 1 % immigration of labour force: medium skilled only• 1 % immigration of labour force: low skilled only• Actual immigration shock 1984-1993:

4.9% of labour force in Germany



Brain Gain? (1% immigration of high-skilled)



Middle of the road (1% immigration of medium skilled)



Gains from Ghetto? (1% immigration of less skilled)



1984-1993 immigration shock (actual immigration)



An application to the EU’s Eastern enlargement

• Parameters of the model are estimated for the EU-15 and the NMS-8 following the same procedure

• We simulate the labour supply shock triggered by the EU’s Eastern enlargement 2003-07

· Actual inflow minus expected influx under conditions before Enlargement

· Actual participation rates and qualification structures· Consideration of ‘brain waste’, i.e. employment below

qualification

• Calculate impact for GDP, GDP per capita, native’s factor income, wages, unemployment

· Distinguish effects for skill groups



An application to the EU’s Eastern enlargement

EU-15 NMS-8 EU-23

GDP long run 0.26 -1.10 0.20

GDP short run -0.09 0.25 -0.07

wages long run

-0.00 0.00 0.00

wages short run -0.09 0.25 -0.07

Unemployment long run 0.02 -0.03 0.02

Unemployment short run 0.06 -0.42 0.06



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Theorie und Politik der Europäischen Integration Prof. Dr. Herbert Brücker Lecture 5 Growth...

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