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Special report No 2 / 2002

ISSN 1684-033X

EUROPEAN

ECONOMYEUROPEAN COMMISSION

DIRECTORATE-GENERAL FOR ECONOMIC

AND FINANCIAL AFFAIRS

European integration and the functioning

of product markets

EU

RO

PE

AN

EC

ON

OM

YSp

ecia

l Rep

ort N

o 2

/ 2002

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European Commission

EUROPEAN

ECONOMY

Directorate-General for Economic and Financial Affairs

2002 Special Report Number 2

ar304932ee2_BaT Page i Mardi, 30. septembre 2003 8:54 08

© European Communities, 2003

Printed in Belgium

ar304932ee2_BaT Page ii Mardi, 30. septembre 2003 8:54 08

European integration

and the functioning

of product markets

ar304932ee2_BaT Page iii Mardi, 30. septembre 2003 8:54 08

Abbreviations and symbols used

Member States

B BelgiumDK DenmarkD GermanyEL GreeceE SpainF FranceIRL IrelandI ItalyL LuxembourgNL The NetherlandsA AustriaP PortugalFIN FinlandS SwedenUK United Kingdom

EU European UnionEU-15 European Community, 15 Member StatesEUR-11 Group of 11 Member States participating in monetary union (B, D, E, F, IRL, I, L, NL, A, P, FIN)Euro area Member States currently participating in monetary union (EUR-11 plus EL)(EUR-12)

Currencies

ECU European currency unitEUR euroATS Austrian schillingBEF Belgian francDEM German mark (Deutschmark)DKK Danish kroneESP Spanish pesetaFIM Finnish markkaFRF French francGBP Pound sterlingGRD Greek drachmaIEP Irish pound (punt)ITL Italian liraLUF Luxembourg francNLG Dutch guilderPTE Portuguese escudoSEK Swedish kronaCAD Canadian dollarCHF Swiss francJPY Japanese yenSUR Russian roubleUSD US dollar

iv

ar304932ee2_BaT Page iv Mardi, 30. septembre 2003 8:54 08

Other abbreviations

AU Australiabn, billion 1 000 millionCA CanadaCH SwitzerlandCN ChinaCPI consumer price indexEC European CommissionECB European Central BankECSC European Coal and Steel CommunityEDF European Development FundEIB European Investment BankEMCF European Monetary Cooperation FundEMS European Monetary SystemEMU economic and monetary unionERM exchange rate mechanismEuratom European Atomic Energy CommunityEurostat Statistical Office of the European CommunitiesFDI foreign direct investmentGDP (GNP) gross domestic (national) productGFCF gross fixed capital formationHICP harmonised index of consumer pricesHK Hong KongID IndonesiaILO International Labour OrganisationIMF International Monetary FundIN IndiaJP JapanKR South KoreaLDCs less developed countriesMio millionMrd 1 000 millionMY MalaysiaNCI New Community InstrumentNO NorwayNZ New ZealandOCTs overseas countries and territoriesOECD Organisation for Economic Cooperation and DevelopmentOPEC Organisation of Petroleum Exporting CountriesPH PhilippinesPK PakistanPPS purchasing power standardqoq quarter-on-quarter percentage changeSG SingaporeSMEs small and medium-sized enterprisesTH ThailandTR TurkeyTW TaiwanVAT value added taxyoy year-on-year percentage changeZA South Africa: not available

– none

v

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vii

Contents

Executive summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

A. Dierx, F. Ilzkovitz, K. Sekkat

Chapter 1: European integration and the functioning of product markets: selected issues . . . . . . . . . . . . . . 9

A. Dierx, F. Ilzkovitz, K. Sekkat

Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

1. Analytical framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

2. Strategic response by enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

3. The evolution of industrial specialisation within the European Union . . . . . . . . . . . . . . . . . . . . . . . . . . 22

4. Economic integration and macroeconomic stabilisation in the EU. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

Chapter 2: EMU and the integration of European product markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

R. Davidson, S. Davies, M. Gasiorek, B. Lyons, D. Ulph, R. Vaughan, A. Winters

Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

Executive summary of key findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

1. Analytical background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

2. Price transparency and market equilibria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

3. Interpreting European price data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

4. Econometric analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

5. Market efficiency and the evolution of EU concentration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

6. Using a CGE model to assess the impact of transparency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

Annex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

Chapter 3: Determinants of industrial concentration, market integration

and efficiency in the European Union. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

R. Veugelers, L. Sleuwaegen, I. De Voldere, J. Reynaerts, K. Rommens, L. Rondi, D. Vannoni,

L. Benfratello, S. Davies, P. Egger, M. Pfaffermay

Executive summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109

1. The impact of market integration on corporate structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

2. The EU market share matrices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116

3. Some key industry and firm characteristics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

4. An analysis of trends in key market characteristics across industries and firms. . . . . . . . . . . . . . . . . . . 128

5. A focus on individual sectors and firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172

6. Concentration in European manufacturing and its effect on price dispersion, productivity and profits. 190

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198

References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201

Appendix on the MSM methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205

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viii

Chapter 4: The location of European industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213

K. H. Midelfart-Knarvik, H. G. Overman, S. J. Redding, A. J. Venables

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217

1. Data and measurement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219

2. The specialisation of countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 220

3. The location and concentration of industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231

4. Econometric analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243

5. Service industries in the European Union . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249

6. An EU–US comparison. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 256

Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 257

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 269

Chapter 5: Sector sensitivity to exchange-rate fluctuations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 271

M. Fouquin, K. Sekkat, L. Nayman, J. Malek Mansour, N. Mulder

Executive summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275

1. Do fluctuations of the dollar still matter for Europe? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 278

2. How to measure European industry sensitivity to US dollar fluctuations . . . . . . . . . . . . . . . . . . . . . . . 283

3. The sector exposure for the EU-15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290

4. The estimation of sectors’ sensitivity to exchange-rate fluctuations . . . . . . . . . . . . . . . . . . . . . . . . . . . 294

5. Euro-dollar exchange-rate global impact on European trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305

6. Asymmetries within EU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 319

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320

Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323

List of tables

Table 1 The effects of the SMP and EMU on EU product markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Table 2 Evolution of the production and trade specialisation of the EU Member States (1970–97) . . . . . 23

Table 3 Evolution of intra-industry trade inside the EU (1970–97) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Table 4 Convergence of factor endowments between EU Member States . . . . . . . . . . . . . . . . . . . . . . . . . 24

Table 5 Impact of integration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Table 6 Summary statistics of coefficients of variation, unbalanced sample, March 1994 to March 1996 57

Table 7 Country effects in normalised prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Table 8 1993 snapshot for PLI data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

Table 9 1997 snapshot for PLI data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

Table 10 Changing concentration and intra-EU multinational activity in the sample of industries . . . . . . . 70

Table 11 Industry characteristics. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

Table 12 Detailing the experiment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

Table 13 Percentage change in output by industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

Table 14 The impact of transparency by country . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

Table 15 The impact of monetary union in Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

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Table 16 Actual and simulated differences in European price dispersion . . . . . . . . . . . . . . . . . . . . . . . . . . 92

Table 17 The impact of transparency by country . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93

Table 18 Transparency and welfare: % change in compensating variation as a proportion of manufacturing value added . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

Table 19 Definition of A. C. Neilsen sample of consumer products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

Table 20 Sectoral characteristics of the 1997 matrix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

Table 21 Coverage and concentration by sector, 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

Table 22 Geographic dimensions of the 1997 matrix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121

Table 23 Summary statistics by Member State, 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122

Table 24 Sectoral and geographic dimensions of the 1987–93–97 matrices . . . . . . . . . . . . . . . . . . . . . . . . 124

Table 25 Coverage and concentration by sector, 1987–93–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

Table 26 Summary statistics by Member State, 1987–93–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

Table 27 Deriving the weighted average C5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

Table 28 Applying the two typologies to disaggregate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129

Table 29 Frequencies of change in C5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130

Table 30 The outliers in more detail . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131

Table 31 Some descriptive simple regressions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131

Table 32 Turbulence in top five leadership by industry, 1987–93–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133

Table 33 Decomposition of C5 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137

Table 34 Decomposition of the average C5 in 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138

Table 35 Sectors with a substantial new entry market share in 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139

Table 36 Sectors with a dominant and persistent leader . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142

Table 37 Sectors with a dominant but non-persistent leader. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143

Table 38 Sectors with high C1 1987, high C1/C5 1987 and stable leader . . . . . . . . . . . . . . . . . . . . . . . . . . 143

Table 39 Country shares of matrix production, 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144

Table 40 Home production versus foreign firm production by Member State, 1997 . . . . . . . . . . . . . . . . . . 145

Table 41 Country shares of foreign firm production, 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146

Table 42 Country shares of matrix production, 1987–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146

Table 43 Number of firms and average home production per firm, 1987–97. . . . . . . . . . . . . . . . . . . . . . . . 147

Table 44 Share of home production versus foreign firm production in total production located in a country, 1987–97. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147

Table 45 Concentration of total foreign firm production, 1987–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148

Table 46 Overall, geographical dispersion of matrix production within the EU, 1987–97 . . . . . . . . . . . . . 150

Table 47 Industries with highest and lowest level of geographical dispersion, 1997 . . . . . . . . . . . . . . . . . . 151

Table 48 Industries with largest positive and negative change in geographical dispersion, 1987–97 . . . . . 153

Table 49 Industries with largest positive and negative change in entropy between, 1987–97 . . . . . . . . . . . 153

Table 50 Geographical dispersion by different product-type industries, 1987–97 . . . . . . . . . . . . . . . . . . . . 154

Table 51 Geographical dispersion and SMP sensitivity, 1987–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154

Table 52 Geographical dispersion at the individual firm level, 1987–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . 155

Table 53 Changes in multinationality of EU matrix firms, 1987–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156

Table 54 Multinationality and firm size, 1987–97 (average values). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157

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Table 55 Number of transnationals and country of origin (simple frequencies), 1987–97 . . . . . . . . . . . . . 158

Table 56 Multinationality and country of origin (average values), 1987–97 . . . . . . . . . . . . . . . . . . . . . . . . 158

Table 57 Multinationality of EU matrix survivors, 1987–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

Table 58 Multinationality of EU versus non-EU firms, 1987–97 (average values) . . . . . . . . . . . . . . . . . . . 159

Table 59 Multinationality by different product-type industries, 1987–97 . . . . . . . . . . . . . . . . . . . . . . . . . . 160

Table 60 Multinationality and SMP sensitivity, 1987–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160

Table 61 Changes in the matrix between 1987, 1993 and 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161

Table 62 Diversification by firm size, 1987–93–97 (three-digit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162

Table 63 Diversification by country of origin 1987–93–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

Table 64 Distribution of diversification across firms, 1987–93–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

Table 65 Distribution of diversification across firms, 1987–93–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165

Table 66 Changing diversification strategies. The transition matrix from 1987 to 1997 . . . . . . . . . . . . . . . 166

Table 67 Diversification by industry type; 1987–93–97. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167

Table 68 Diversification of survivors, entrants and exitors, 1987–93–97 . . . . . . . . . . . . . . . . . . . . . . . . . . 169

Table 69 The incidence of diversified and multinational firms in 1987 and 1997 . . . . . . . . . . . . . . . . . . . . 169

Table 70 Correlation matrix of firm diversification, multinationality, size, and growth . . . . . . . . . . . . . . . 170

Table 71 Growth rates of size, diversification and multinationality by initial (1987) levels of diversification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171

Table 72 Overview of Danone’s activities and its positioning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173

Table 73 Internationalisation of Danone. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174

Table 74 The top five players in each of Danone’s main sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175

Table 75 Dynamic overview of multinationality and diversification ratios of Danone and Nestlé . . . . . . . 175

Table 76 Companies’ rank in the pasta industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178

Table 77 EU leaders’ product and geographic diversification (numbers equivalent). . . . . . . . . . . . . . . . . . 178

Table 78 Growth rates of producer price in some EU countries between 1988 and 1996 (percentages) . . . 180

Table 79 Five leading brewers in the EU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183

Table 80 Level of diversification of leading European brewers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184

Table 81 Level of production multinationality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185

Table 82 Some key characteristics of ICT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 186

Table 83 Multinationality in ICT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 187

Table 84 Top 5 Matrix firms in sectors 23–26 (1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 188

Table 85 In- and outward diversification within sectors 23–26 (1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 188

Table 86 In- and outward diversification between sectors 23-26 and 19 (1997) . . . . . . . . . . . . . . . . . . . . . 189

Table 87 Descriptive statistics — quantiles of entropy of multinational production, 1987–97 . . . . . . . . . . 191

Table 88 Descriptive statistics — quantiles of concentration ratios (CR5), 1987–97 . . . . . . . . . . . . . . . . . 191

Table 89 Regression analysis of productivity growth in European industry . . . . . . . . . . . . . . . . . . . . . . . . 193

Table 90 Descriptive statistics — price convergence across industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194

Table 91 Descriptive statistics — convergence in price level and concentration, 1993–96. . . . . . . . . . . . . 194

Table 92 Regression results — convergence in price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195

Table 93 Descriptive statistics — convergence in price level and multinationality, 1993–96 . . . . . . . . . . . 195

Table 94 Price cost margins and concentration in EU manufacturing, 1987–93–97 . . . . . . . . . . . . . . . . . . 196

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Table 95 Industry classification. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209

Table 96 Krugman specialisation index (production data, four-year averages) . . . . . . . . . . . . . . . . . . . . . . 221

Table 97 Summary measures of relative shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222

Table 98a Bilateral differences, 1980–83 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224

Table 98b Bilateral differences, 1994–97 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224

Table 99a Krugman specialisation index: exports (four-year averages). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225

Table 99b Krugman specialisation index: imports (four-year averages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225

Table 100 Industry characteristic bias 1994/97. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 230

Table 101 Regional structure of European manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231

Table 102 Change in sectoral Gini coefficients of concentration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232

Table 103 Industries grouped by levels and changes in concentration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233

Table 104 Industry characteristics. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236

Table 105 Interaction variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244

Table 106 Regression results. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247

Table 107 Country shares of the EU financial, insurance, real estate and business service sector (FIRE) . . 251

Table 108 Service-intensive industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251

Table 109 Gini coefficients of specialisation: United States and EU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253

Table 110 Gini coefficient of concentration: United States and EU. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254

Table 111 European and US motor vehicle production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254

Table 112 EU conditional spatial separation/US conditional spatial separation. . . . . . . . . . . . . . . . . . . . . . . 255

Table 113 Country characteristics (1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259

Table 114 Gini coefficient of concentration (EU-14) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262

Table 115 Spatial separation (EU-14) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263

Table 116 Gini coefficient of concentration (US-51) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263

Table 117 Daisie (EU-14), industry classification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264

Table 118 Daisie (EU-14) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 266

Table 119 EU-15: the nature of intra- and extra-EU trade (1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279

Table 120 International trade by currency: some estimates (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285

Table 121 i Currencies’ relative volatility to the dollar or to the ecu . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286

Table 121 ii Currencies’ relative volatility to the dollar or to the ecu . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287

Table 122 Market shares in the European Union, the dollar zone and third countries, 1996 . . . . . . . . . . . . . 291

Table 123 The sector exposure of EU-15 to the competition from the dollar zone, 1996 . . . . . . . . . . . . . . . 293

Table 124 Selected sector indicators: EUR-11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295

Table 125 Estimation results of equations (3) and (4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 298

Table 126 Import and export equation: t-statistics for equality of exchange-rate coefficients for couples of sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 299

Table 127 Estimation results of equations (10) and (11) using concentration ratio . . . . . . . . . . . . . . . . . . . . 301

Table 128 Estimation results of equations (10) and (11) using the segmentation indicator . . . . . . . . . . . . . . 302

Table 129 Estimation results of equations (10) and (11) using the intensity of scale economies. . . . . . . . . . 303

Table 130 Estimation results of equations (12) and (13) using all market structure indicators . . . . . . . . . . . 304

Table 131 Four sectoral types . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 306

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Table 132 Changes in market shares following a 10 % depreciation of the dollar. . . . . . . . . . . . . . . . . . . . . 307

Table 133 Industry and market structures in the EU-15, in 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 309

Table 134 Four market types. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 310

Table 135 Summary of sectoral characteristics — strongly exposed sectors in the EUR-11. . . . . . . . . . . . . 311

Table 136 Indicators of exposure for France. Germany and UK to competition from the dollar zone . . . . . 313

Table 137 Global exposure of individual EU members . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 313

Table 138 Indicators of exposure for Ireland and Portugal to competition from the dollar zone, 1996. . . . . 314

Table 139 Sectors exposure to the dollar zone . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315

Table 140A Asymmetries by country and by industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315

Table 140B Asymmetries by country . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 316

Table 141 Breakdown of value added and employment according to the nature of the industries involved, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 317

Table 142 Asymmetrical shock-sectors: sensitivity to exchange-rate fluctuations . . . . . . . . . . . . . . . . . . . . 317

Table 143 High exposure/high sensitivity ‘asymmetric’ sectors, in % of total in the country . . . . . . . . . . . . 318

List of figures

Figure 1 Changes in production and trade specialisation (1988–98) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Figure 2 Typology of economic shocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Figure 3 Production share of US dollar sensitive sectors (Average 1995–99). . . . . . . . . . . . . . . . . . . . . . . 29

Figure 4 Analytical framework for analysing the impact of integration . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

Figure 5 Impact of integration on market structure and on prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

Figure 6 Impact of integration in R & D and advertising-intensive industries . . . . . . . . . . . . . . . . . . . . . . 49

Figure 7 Mean cv over time, EUR-16, unbalanced sample . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

Figure 8 CVs for Core-four and non-core . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

Figure 9 Weighted and unweighted CVs, March 1996, Neilsen sample . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

Figure 10 Core vs non-core CVs, NACE-2, 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

Figure 11 Correlation of output changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

Figure 12 Change in consumer transparency: correlation of changes with key characteristics . . . . . . . . . . . 85

Figure 13 Change in producer transparency: correlation of changes with key characteristics . . . . . . . . . . . 87

Figure 14 Correlations in changes in concentration, output and mark-up . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

Figure 15 Recent changes in industry globalisation drivers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

Figure 16 Transition from fragmented national markets to a single European market . . . . . . . . . . . . . . . . . 113

Figure 17 Linking turbulence to changes in concentration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141

Figure 18 Change in distribution of relative entropy across industries, 1987 versus 1997 . . . . . . . . . . . . . . 152

Figure 19 Market share of top one, two or three brewers, 1997 (number of brewers in brackets) . . . . . . . . 182

Figure 20 Countries grouped by EC entry date . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222

Figure 21 Industry characteristic bias of countries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227



Figure 24 Industry Gini coefficients: industries grouped by performance. . . . . . . . . . . . . . . . . . . . . . . . . . . 233

Figure 25a Country characteristic bias of industries: market potential . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 238

Figure 25b Country characteristic bias of industries: wage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239

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Figure 25c Country characteristic bias of industries: high skills . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240

Figure 26 Spatial separation of manufacturing industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241

Figure 27 Share of employment in the service sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249

Figure 28 Gini coefficient of concentration — EU services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250

Figure 29 EU-12: the nature of intra-EU trade (1980–95) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280

Figure 30 Unit labour costs in manufacturing (1990 = 100) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 281

Figure 31 US dollar/euro and yen/euro exchange rates, 1979–98 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282

Figure 32 Market penetration (M/D), Manufactures 1970–96 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292

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1

Executive summary

by Adriaan Dierx (1), Fabienne Ilzkovitz (2) and Khalid Sekkat (3)

Introduction 1 2 3

The 10-year anniversary of the single market programme(SMP) offers an excellent opportunity to look back andreflect on its impact on the functioning of product mar-kets in the European Union. Of course, EU markets forgoods and services have been affected by other develop-ments — globalisation, economic and monetary union(EMU) — but it is fair to say that the SMP has been andcontinues to be an important driver of change in EUproduct markets. Ten years after the ‘achievement’ ofthe single market programme , the renamed internal mar-ket strategy remains a key element of economic policy-making in the EU. Creating a truly integrated and effi-cient market requires continuous and relentless effortand support. EMU supports the internal market by facil-itating cross-border transactions and making marketsmore transparent. The reduction in cross-border transac-tion costs and the elimination of exchange-rate riskwithin the euro area should stimulate trade and foreigninvestment. Moreover, the increased clarity of differ-ences in price levels between Member States shouldencourage arbitrage and contribute to price convergence.

In this volume of European Economy, we look at theimpact of this ongoing market integration process andthe product market reforms associated with it (includingin particular the SMP and EMU) on the level of compe-tition in EU product markets, the strategic behaviour offirms, the structure and location of European industry

and the impact of these developments on the Union’sexposure to asymmetric shocks. The volume contains anintroductory chapter providing a framework for analysisand four external studies that have recently been carriedout for the Directorate-General for Economic and Finan-cial Affairs.

This work should be seen in the political context ofrecent efforts by the European Union to improve productmarket surveillance and to better coordinate economicreforms. The ‘Cardiff’ process of economic reform,which was launched at the Cardiff European Council inJune 1998, and includes elements of peer review andbenchmarking, aims at improving the functioning ofEuropean product and capital markets, in particular. TheLisbon strategy, launched by the Lisbon EuropeanCouncil of March 2000, is a more broadly based struc-tural reform effort that aims at transforming the Euro-pean Union into ‘the most competitive and dynamicknowledge-based economy in the world […]’. ForEurope to rise up to this challenge, a wide range of policymeasures need to be taken that are targeted in particularat raising the potential growth rate of the EuropeanUnion. In order to ensure the effectiveness of nationaland EU-wide economic policies within this context, thebroad economic policy guidelines (BEPGs) focus onthose measures that need to be taken most urgently.

The report is organised as follows: Chapter 1 highlightsthe different channels through which market integrationaffects the functioning of product markets. In pulling thefour expert studies together, it provides a comprehensiveframework for assessing the performance of EU productmarkets. Chapter 2 focuses on the functioning of marketsin an economic and monetary union. It investigates theimpact of the increase in price transparency associatedwith the arrival of the euro on the capacity of enterprises

¥1∂ Directorate-General for Economic and Financial Affairs of the EuropeanCommission. The paper has been written under the sole responsibility ofthe authors and does not reflect the views of the European Commission.

¥2∂ Directorate-General for Economic and Financial Affairs of the EuropeanCommission, Université Libre de Bruxelles and ICHEC.

¥3∂ Université Libre de Bruxelles and Directorate-General for Economic andFinancial Affairs of the European Commission.

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E u r o p e a n i n t e g r a t i o n a n d t h e f u n c t i o n i n g o f p r o d u c t m a r k e t s

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to segment markets and maintain differences in pricelevels between Member States. Under the presumptionthat the increase in price transparency is larger for con-sumers than that for producers, the study shows thatEMU will increase competition, reduce mark-ups andcreate welfare gains. Chapters 3 and 4 look at enterprises’reactions to the change in economic environment broughton by the SMP in particular. In Chapter 3, different pro-duction and marketing strategies (affecting the scale ofproduction, the location of production facilities and thedegree of diversification into non-core business) are con-sidered as well as the effects of such strategies on thestructure of industry. Chapter 4 gives a more detaileddescription of changes that have occurred in the locationof industry over the recent decades. It relates the changesobserved in national specialisation and the geographicalconcentration of industries to country and industry charac-teristics. Chapter 5 is more forward looking. It identi-fies the sectors that under EMU are the most sensitive tofluctuations in the euro/dollar exchange rate. In this chap-ter, sector sensitivity is viewed as being dependent on thethe sector’s exposure to competition from the dollar zoneand on its trade elasticity to exchange-rate fluctuations.

1. European integration and the functioning of product markets: a framework for analysis

The increased integration of European product marketsover the last decade has modified the conditions underwhich firms compete. The reduction of barriers to intra-EU trade and other cross-border activities and theincreased price transparency within the euro area canboth be seen as factors that raise the level of competitionin product markets. Conceptually, the increased competi-tion should reduce prices and mark-ups, leading to themarket exit of the least efficient firms. This should resultin gains in allocative and productive efficiency. On theone hand, allocative efficiency would be expected toincrease because price levels would move closer to themarginal costs due to the decrease in market power of thecompeting firms. On the other hand, the market exit of theleast efficient firms should result in a reduction in aver-age costs and thus to an increase in productive efficiency.

Firms are expected to react to the increased intensity ofcompetition by modifying their strategies in order torestore their profitability through either cost reductionsor measures aimed at raising their market power. Suchmeasures, in turn, may lead to a change in the competi-

tive interaction among firms, the implications of whichare considered in Chapters 1 and 2. Here, one may thinkabout a switch from non-collusive to collusive behav-iour, from competition on quantities to competition onprices (1), or from a segmented market to an integratedmarket strategy where firms treat the whole EU marketas a single market in which they adopt a unified pricingstrategy. A priori, it is difficult to decide what the netimpact of such changes in strategic behaviour on prices,mark-ups, market structure and the location of industrialactivity will be. The approach taken by Dierx, Ilzkovitzand Sekkat in Chapter 1 is to describe the viewsexpressed in the mainstream of the economic literature.One key result is that the strategic reaction by firms isunlikely to offset the positive effect of the integrationprocess on the allocative and productive efficiency of theEuropean economy. In addition, lower mark-ups andprices contribute to increased welfare.

The chapter also considers the impact of integration onthe production and export specialisation of the EU Mem-ber States. There are forces working in opposite direc-tions. On the one hand, the removal of barriers to tradeshould lead to a reduction in transport and transactioncosts and thus allow a better exploitation of scale econo-mies in production. Such developments would bereflected in an increased specialisation of the MemberStates. On the other hand, the stronger intra-industrytrade linkages observed in integrated economies, whichare attributed mostly to the convergence of factorendowments and increased product differentiation,would lead one to expect a decline in industrial speciali-sation. Both arguments have found some empirical sup-port. While measures of production specialisation havebeen rising since the early 1980s, export specialisationhas remained more or less unchanged and there has beena notable increase in the relative importance of intra-industry trade. Chapter 4 offers further insights into theunderlying factors determining the location of economicactivity in the European Union.

One of the arguments for analysing changes in the pro-duction and export specialisation of Member States isthat such changes may affect country exposure to asym-metric shocks. With the loss under EMU of theexchange-rate instrument as a tool for handling asym-

¥1∂ As price levels are lower under price competition, firms have greater incen-tives to collude in this case. However, with differentiated products, the dif-ference between competition on quantities and competition on prices is lessimportant.


E x e c u t i v e s u m m a r y

3

metric shocks, it is an issue that once again has come to thefore. The latter part of Chapter 1 is devoted to the questionof whether fluctuations in the euro/dollar exchange raterepresent an asymmetric shock, and if so, how has theEuropean integration process affected the exposure to thistype of shock? The analysis shows that euro/dollar fluctu-ations indeed represent an asymmetric shock, providedthat there is a variation between sectors in terms of theirsensitivity to exchange-rate fluctuations and that there is adifference between countries in the economic weight ofthese so-called ‘sensitive’ sectors (1). As the two condi-tions are indeed fulfilled, we can give a positive responseto the first question and turn to the second one.

How does European integration affect country exposureto fluctuations in the euro/dollar exchange rate? Twochannels are identified in this chapter. First, as the singlemarket programme was targeted specifically at raisingthe level of competition in some of the least competitivesectors, a reduction in the differences between sectors interms of competition levels should be expected, whichshould result in a decline of country differences in termsof exchange-rate sensitivity as well. Second, the increasein the 1990s of both production specialisation and intra-industry trade leaves doubt about the direction of the spe-cialisation effect. As there are forces working in oppositedirections, the chapter concludes that the net effect ofEuropean product market integration on the exposure ofEU Member States to movements in the euro/dollarexchange rate has probably been relatively small.

2. EMU and the integration of European product markets

Chapter 2 by Gasiorek et al. considers two key aspects ofproduct market integration in the EU. On the one hand,it analyses the impact of European integration on pricelevels, price dispersion and price/cost margins. It does soby comparing available price data over the 1990s in theEU ‘core’ and ‘non-core’ countries, ‘core’ referring notonly to countries having stabilised their exchange ratesbut also characterised by deep long-standing realconnections (2). The objective is to test the theoreticalargument according to which some reduction in pricedispersion is expected to arise from the greater integra-tion and exchange rate stability resulting from EMU.

This analysis shows that between 1993 and 1997, signif-icant price convergence was visible for the core coun-tries, while a significant divergence away from the EUaverage was detected for other countries — upwards inScandinavia and downwards in the Iberian peninsula.

On the other hand, the chapter proposes a microeconomicmodel describing the channels through which the greatertransparency of prices may be expected to influence themarket equilibrium and utilises a computable generalequilibrium model to assess the possible impact of thegreater transparency of prices on output, Lerner price/cost margins (3) and welfare. The microeconomic modelmakes the distinction between three channels throughwhich a rise in price transparency may affect price/costmargins. First, an increase in price transparency improvesthe information available to consumers, thus reducing thesearch costs and facilitating price comparisons betweenproducts. Second, it gives additional information to pro-ducers and widens the possibilities of collusion betweenfirms. Third, it creates possibilities of arbitrage of con-sumers and wholesalers between countries and thereforeincreases the price elasticity of demand. The first and thethird mechanisms should reduce the price/cost margin,while the second one should increase it. On the whole,price transparency has opposite effects on price levelsand price/cost margins depending on whether it makes iteasier for consumers or producers to detect price changes.In addition, if the better information available to consum-ers makes it more difficult for producers to segment mar-kets, the dispersion of price levels between EU MemberStates would be expected to show a decline. However,whether such a reduction in price dispersion is associatedwith a downwards or an upwards movement in price lev-els depends on whether the higher level of competitionassociated with the better information available to con-sumers is not offset by the improved ability of implicitcollusion by producers.

In that respect, the chapter argues that the costs to thelarge producers of collecting information on pricesacross markets are relatively low and that therefore thesingle currency will likely have a relatively limitedimpact on the information available to producers. Thegreater impact would come from the improved consumerprice transparency and from the greater scope for arbi-trage to dismantle marketing strategies based on pricediscrimination.

¥1∂ Chapter 5 focuses on the identification of such exchange-rate sensitivesectors.

¥2∂ The core countries include Belgium, France, Germany, Luxembourg andthe Netherlands. ¥3∂ Defined as the ratio ‘(price – marginal costs) / price’.



4

With the arrival of the euro, consumers can make a moreinformed choice between buying identical products oneither side of the border. While the SMP facilitated theintroduction of new brands into the different nationalmarkets, raising inter-brand competition, the use of theeuro should create intra-brand competition. However,the extent to which this is happening in reality dependson the nature of the product in question (homogeneous ordifferentiated, final or intermediate), the way in whichbuyers are organised (e.g., in cooperatives) and the ver-tical linkages between buyers and sellers (through own-ership and contracts). The competitive effects from thehigher price transparency should be lower in industrieswith differentiated products because it is more difficultfor consumers to compare prices, in industries sellingintermediate products to other firms because producershave already good information on prices, in highly con-centrated industries because the degree of collusioncould be greater, and in industries with strong verticallinkages which allow to preserve price discrimination.

Building on the above theoretical analysis, a computablegeneral equilibrium model is developed comprising15 countries and 50 manufacturing sectors in order toinvestigate the potential impact of the greater price trans-parency on economic welfare. This model distinguishesthe effects of greater price transparency for producers andfor consumers, which have offsetting effects. While anincrease in price transparency for producers has a positiveimpact on the Lerner price/cost margin, the increase inprice transparency for consumers has a negative impact.Different scenarios are considered, depending on whetherthe measures of the consumer and producer transparencyare equal or different across industries (for example, themeasure of the producer information which determinesthe risk of collusion is supposed to be greater in moreconcentrated industries) and on whether the changes inthe consumer transparency are equal or differentiatedacross industries (for example, the increase in the con-sumer information associated with the euro is assumed tobe greater in industries selling homogeneous productsthan in industries selling differentiated products).

Simulation results (1) show increased output as a resultof increased price transparency for producers andconsumers in a great number of manufacturing sectorsand lower mark-ups in all of them but one. Therefore, if

the single currency in Europe does have a positiveimpact on consumer transparency, one can expect pro-competitive effects resulting in an increase in output anda decrease in price/cost margins. While collusive behav-iour of producers is likely to diminish the positive effectsof increased consumer price transparency, it is veryunlikely that it will be strong enough to completelyundermine the benefits. The effects of the greater pricetransparency are also different across industries: a givenchange in the consumer transparency is likely to have agreater impact on mark-ups the more differentiated andthe more concentrated is the industry. However, theincrease in consumer transparency will also vary acrosssectors and should be lower in these industries. Finally,the shift to integrated markets where firms adopt a uni-fied pricing strategy should represent a much more pro-competitive effect than a simple change in consumerprice transparency. To some extent, this shift is alsorelated to the capacity of producers to segment marketsand this capacity should be reduced by the higher pricetransparency.

3. Determinants of industrial concentration, market integration and efficiency in the European Union

This third chapter by Veugelers et al. has the doubleobjective of first assessing the impact of the Europeanintegration process on the corporate structure of indus-try, and second, of making the link between corporatestructure and industrial performance. The chapterconsiders different aspects of corporate structure: pro-duction concentration (i.e. the market share (2) of thefive largest firms in an industry); turbulence in marketleadership, the geographical concentration of produc-tion in the EU; multinationality, as measured by theimportance of production outside the home market andthe number of countries in which a firm has productionfacilities; and diversification (i.e. presence in differentindustries).

During the period of analysis (1987–97), the single mar-ket programme came to fruition. A priori, the achieve-ment of the single market and the higher levels of com-petition associated with it should affect both companystrategy and industry structure (see Section 1). The

¥1∂ The simulations are partially assumption driven, in the sense that they assumethat under EMU consumer transparency will increase more than producer trans-parency. However, there is some evidence to show that this is indeed the case.

¥2∂ In this chapter, the market share of a firm in a specific manufacturing sectoris measured by the value of company sales of goods produced inside theEU as a share of total EU production in that sector.



5

greater ease of entry into other EU markets may inducefirms to expand production and sales across national bor-ders. The larger market place may also increase thescope for product differentiation. Only in relatively largemarkets are producers able to satisfy the different tastesof consumers for a reasonable price. On the other hand,the tougher competition within Europe’s internal marketmay lead to the exit of the least efficient firms or forcefirms to re-focus their activities on core activities inorder to ensure survival. At the industry level, such stra-tegic actions of individual enterprises may be reflectedin higher concentration levels as well as a change in geo-graphical concentration of economic activity.

These various possible developments have been investi-gated with the help of a market share matrix, whichshows for every manufacturing sector the share of EUproduction of the five largest firms and for every firmincluded in the sample (i.e. those firms amongst the topfive in at least one sector) the distribution of productionacross sectors and Member States. The market sharematrix was constructed for three years (1987, 1993 and1997), which permitted the tracking of the changes overtime. As only large firms were represented in the marketshare matrix, a selection bias was unavoidable.

The main results of these investigations were as follows.On average, there was quite some turbulence in marketleadership during the period under investigation, whichsupports the main underlying presumption that the singlemarket programme has served to increase the level ofcompetition on European product markets. The observa-tion that the multinational character of matrix firms hasstrengthened over time provides additional support forsuch a conclusion. This observation is associated in partwith an increased presence of non-EU firms in theUnion. In sharp contrast with the results for EU firms,however, the level of multinationality of non-EU firmsrose only marginally from an admittedly higher initiallevel. The decline in the average number of countries inwhich non-EU firms have production facilities suggestsa strengthening of efforts to rationalise EU productionby those firms. Firms with a home base in one of thesmaller EU Member States remained more multinationalin character than those based elsewhere. The data alsoshow a decline in the degree of diversification of largeEuropean enterprises into sectors not directly associatedwith their core businesses. It appears that the competitiverise of R & D and advertising expenditures in the largerand more integrated market has encouraged firms todivest from secondary activities.

In spite of the observation that over the 10-year periodunder investigation the incumbent top five companieslost half of their market share to newcomers, productionconcentration did not change very much on average,even if there were large differences between sectors.High concentration sectors showed more persistence inleadership. There was also some evidence that profitabil-ity in such sectors was higher. On the other hand, thespeed of price convergence between EU Member States(an indicator of market integration) and labour produc-tivity growth in those sectors were lower, which wouldseem to indicate that excessive concentration has a neg-ative impact on the integration and efficiency of Euro-pean product markets. Finally, the chapter presents evi-dence of relatively minor movements in the geographicaldispersion of production between EU Member States.The following chapter provides a more in-depth discus-sion of this particular issue.

4. The location of European industry

Chapter 4 by Midelfart-Knarvik et al. tracks the impactof market integration on country specialisation and thegeographical concentration of manufacturing activity inthe European Union. Since the early 1980s there hasbeen a gradual increase in production specialisation,which has been rather more abrupt in countries joiningthe European Union recently than in its long-term mem-bers, which would seem to indicate that EU enlargementis as important a factor in the integration process as theSMP or EMU. Contrary to the overall development, thespecialisation of large Members such as France, the UKand Germany in high-technology and high returns toscale industries has been declining slightly. At the sametime, Ireland and Finland have become increasingly spe-cialised in such industries. Nevertheless, the usual divi-sion between the north and central Europe, on the onehand, and the south, on the other remains valid with thenorthern countries more specialised in increasing returnsand high-tech industries.

The data on export specialisation — contrary to those onproduction specialisation — show no clear increase inthe 1980s and 1990s. This discrepancy is explained bythe rapid growth of intra-industry trade, which hastended to make sectoral trade vectors more similarbetween countries.

At the aggregate level, the geographical concentration ofmanufacturing production in the EU has remained moreor less unchanged since the early 1980s, with the effects



6

of the rise in production specialisation being offset byrelatively faster growth of the smaller Member States.At the level of individual industries, more significantchanges in the degree of concentration could beobserved. Medical and precision instruments and radio,television and communication equipment are amongstthe industries with the sharpest declines in concentra-tion. In these industries, peripheral countries like Irelandand Finland have made inroads at the expense of Ger-many, France and the UK. For motor vehicles, on theother hand, the already high level of concentration hasrisen further, as Germany has reinforced its position atthe expense of both France and the UK. Low-tech andlabour-intensive industries also show a tendency towardsincreased concentration. In textiles and clothing, forexample, the already important share of the south Euro-pean countries has risen further.

While difficult to compare, the geographical concentra-tion of economic activity in US manufacturing appearsto have remained above that in the EU. However,concentration levels in the United States have declinedsteadily since the 1970s, while those in the EU havefailed to show a clear tendency.

This more descriptive part of Chapter 4 is followed by ananalysis of the determinants of location in the EU. Thechapter shows that a high proportion of the cross-countryvariation in industrial structure between EU MemberStates can be explained by the interaction between coun-try and industry characteristics. The location of R & D-intensive industries, for example, has become increas-ingly responsive to countries’ endowments of research-ers. Similarly, backward and forward linkages betweenindustrial sectors are becoming increasingly importantdeterminants of location. Auto parts suppliers, for exam-ple, have shown a tendency to locate ever closer to motorvehicle assembly plants. Economies of scale, on theother hand, have been steadily declining as a locationfactor in the European Union.

5. Sectoral sensitivity to exchange-rate fluctuations

This final chapter by Fouquin, Sekkat et al. focuses onthe likely impact of the euro/dollar fluctuations on theEuropean Union manufacturing trade. Leaning on pre-vious theoretical and empirical research which empha-sises the difference in sensitivity to exchange-rate fluc-tuations across sectors, the chapter tries to classifyEuropean sectors according to their sensitivity to the euro/

dollar fluctuations. The degree of sensitivity of a givensector depends on its exposure to competition from thedollar zone and on its trade elasticity to exchange-ratefluctuations. Both aspects are investigated. In addition,the study examines the extent to which market structureinfluences elasticities.

In order to assess the degree of exposure to competitionfrom the dollar zone, an indicator is constructed whichtakes into account the fact that the dollar zone (i.e. thezone of currencies which fluctuates more or less inconjunction with the dollar) is larger than just the USeconomy. Moreover, the indicator takes into accountboth competition by imports in the EU market and com-petition to the EU exports in the dollar zone and in thirdmarkets. The results show that textile products, leatherproducts, machinery and equipment, electrical opticalequipment and transport equipment and, to a lesserextent, chemicals are the sectors facing the maximum ofcompetition from the dollar zone. Competition concernsboth the European and foreign markets. However, in themachinery and equipment and the chemical sectors com-petition with the dollar zone is intense only in foreignmarkets.

In order to assess the elasticity of trade in the differentsectors to exchange-rate fluctuations, an econometricanalysis is conducted. It addresses two issues: the differ-ence of elasticities across sectors and the extent towhich market structure explains such a difference. Theregression relates trade volumes to exchange-rate varia-bles, cost variables and market structure variables. Itfocuses on bilateral imports and exports of 11 declaringcountries from or to 17 partners for 14 sectors. Theresults show that cost considerations and exchange rateare important determinants of trade. Exchange-rate vol-atility has an adverse effect on imports only. However,the key issue here is that the elasticity of trade toexchange-rate changes varies across sectors. These var-iations are explained by market structure. The moreconcentrated is a sector, the less exchange-rate changewill affect its trade. The sectors with high elasticity areenergy (in spite of a high concentration at the EU level,competition on prices in the energy sector is veryintense), food, paper products, machinery, electricalproducts for imports and energy, machinery and trans-port equipment for exports.

Combining the exposure indicator and the elasticity esti-mates, a sectoral classification emerges where the mostsensitive sectors to the euro/dollar fluctuations are



7

machinery and equipment, electrical and optical prod-ucts and transport equipment. These sectors togetherrepresent about one third of European output. Textilesand leather (low elasticity/high exposure) make up onlya small share of the economy. Except for basic metals,the low elasticity-low exposed sectors (wood and wood

products, rubber and plastic products, other non-metallicmineral products and basic metals and fabricated metalproducts) do not account for much total value added inEurope. On the contrary, among the remaining sectors,energy, food and paper (high elasticity/low exposure)represent an important share of the European economy.


Chapter 1

European integration and the functioning of product markets: selected issues

Adriaan Dierx (1)Fabienne Ilzkovitz (2)Khalid Sekkat (3)

¥1∂ Directorate-General for Economic and Financial Affairs of the European Commission. The paper has been written under the sole responsibility of the authors anddoes not reflect the views of the European Commission.

¥2∂ Directorate-General for Economic and Financial Affairs of the European Commission, Université Libre de Bruxelles and ICHEC.¥3∂ Université Libre de Bruxelles and Directorate-General for Economic and Financial Affairs of the European Commission.


11

Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

1. Analytical framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

1.1. The single market programme. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

1.2. Economic and monetary union . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

2. Strategic response by enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

2.1. Welfare implications of product market integration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

2.2. Cost-reduction strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

2.3. Strategies aimed at increasing market power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

3. The evolution of industrial specialisation within the European Union . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

4. Economic integration and macroeconomic stabilisation in the EU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

4.1. The framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

4.2. The impact of exchange-rate fluctuations across sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31


12

Abstract

This chapter tracks the process of European integration(including in particular the single market programmeand economic and monetary union) and assesses itsimpact on a number of structural characteristics of EUproduct markets (level of competition and market effi-ciency; industrial specialisation of the EU MemberStates; and the likelihood of asymmetric shocks result-ing from fluctuations in the euro/dollar exchange rate).A distinction is made between the effects of the lowerbarriers to market entry (due to both the SMP andEMU) and the impact of increased price transparency(mostly associated with EMU). Both developments are

seen as factors that raise the level of competition inproduct markets. In response, firms change their long-term strategies, affecting the range of products that theysell, the geographical spread of their sales territory, andthe location of their production facilities. At the indus-try level, this should be reflected in the degree of con-centration of production in leading firms, the spatialdistribution of economic activity and associated withthat the degree of industrial specialisation of the EUMember States. Such changes in industry structure inturn affect the exposure of EU Member States to asym-metric shocks.


13

Introduction

The process of European integration in the past decadehas been closely associated with the single market pro-gramme (now evolved into the internal market strat-egy) and economic and monetary union. This processhas been pushed forward by highly publicised dead-lines and target dates (1992 for the SMP, 1999 and2002 for EMU) giving a first impression of abruptchange in the economic environment. In practice, how-ever, businesses and consumers tend to anticipate suchchange and modify their behaviour even before the for-mal change is made. On the other hand, often the fullimpact of the economic reforms is felt only years aftertheir introduction. This implies that European integra-tion is a continuous process, one in which the speed ofprogress may be affected by policy initiatives such asthe SMP and EMU.

Moreover, while at a superficial level the timing ofthese key policy initiatives may appear to coincidebetween EU Member States, in practice it can be quitedifferent. Some Member States for instance havereceived temporary derogations on key elements of thesingle market programme. Others have experiencedserious delays in implementing all its provisions. Also,the SMP does not concern all sectors equally or simul-taneously. To the extent that a Member State is special-

ised in SMP-sensitive sectors (1), it will be more imme-diately affected by the SMP. Finally, not all MemberStates participate in the first wave of EMU. All of thisimplies that the impact of the European integrationprocess is likely to differ between Member States. Tothat, one should add the different starting points of thecurrent EU Member States in the early 1990s (withsome countries not yet being EU Members).

The focus of this paper is on how, by changing the struc-ture of European industry, this ongoing but uneven integra-tion process affects the exposure of EU Member States toasymmetric shocks. Section 1 presents a number of main-stream hypotheses, which represent the majority view inthe academic literature on possible integration effects onindustrial structure. Section 2 takes a closer look at the stra-tegic response by European enterprises to the integrationprocess and the increased level of competition resultingfrom it. Section 3 describes recent trends in the industrialspecialisation of the EU Member States. In Section 4, theexposure of different industries and countries to asymmet-ric shocks, particularly those coming from fluctuations inthe euro/dollar exchange rate is considered.

¥1∂ See Buigues et al. (1990) for a definition of industrial sectors most likely tobe affected by the single market.


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1. Analytical framework

The single market programme and economic and mone-tary union are the two centre pieces of the European inte-gration process in the 1990s and the focal points of theanalytical framework presented here. From an economicperspective, the main objectives of the SMP were theelimination of non-tariff barriers to intra-EU trade ofgoods and services and the freeing of cross-bordermovements of production factors. EMU reinforced someof the effects of the SMP by eliminating the exchange-rate risk associated with trade and other cross-borderactivities. However, EMU is going a step further. The

use of common notes and coins across the euro area willmake transparent differences in price levels between thecountries within the area.

The table below, that describes the expected effects ofthe SMP and EMU on product markets, therefore makesa distinction between on the one hand, the effects of thereduction of barriers to intra-EU trade and other cross-border activities (as caused by both the SMP and EMU),and on the other hand, the increased price transparencyassociated mostly with the EMU.

In order to facilitate the analysis, the table distinguishesthe effects of the SMP and EMU in the short-, medium-and long-term. It describes the expected effects on mar-kets (viewed as short-term effects), on the behaviour offirms (in the medium-term), and on the organisation ofindustry (in the long term). The underlying analyticalframework is the c

issn 1684-033x european economy...price (excluding vat) in luxembourg: eur 40 european economy(6...

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