EC4333 Economics of European Integration Lecture 5

Factor Market Integration and Growth

No Lecture Nov 21Makeup: Monday Nov 13

EG003 4-5pm

Milk Prices in Poland

akeup

http://www.ejpau.media.pl/volume9/issue2/art-34.html

Capital Market Integration

capital

MPK

payment to home labour

K0

r0

payment to home

capital

• MPK = marginal productivity of capital• Total output = area underneath MPK curve

• Capital owner get r × K

• Labour gets the rest

r

capital

MPK

payment to home labour

K0

r0

payment to home

capital

• MPK = marginal productivity of capital• Total output = area underneath MPK curve

• Capital owner get r × K

• Labour gets the rest

r MPK(K=1)

K=1

Microeconomics of Capital Market Integration

r’

r0*

r0

r’

K0 K0* K0+K0*

K’

MPK

MPK* MPK

MPK*

Microeconomics of Capital Market Integration

r’

r0*

r0

r’

K0 K0* K0+K0*

K’

MPK

MPK* MPK

MPK*

1 2 3 4 5 6 7 8 9 10 11

Microeconomics of Capital Market Integration

r’

r0*

r0

r’

K0 K0* K0+K0*

K’

MPK

MPK* MPK

MPK*

1 2 3 4 5 6 7 8 9 10 11 10 9 8 7 6 5 4 3 2 1

Microeconomics of Capital Market Integration

r’

r0*

r0

r’

K0 K0* K0+K0*

K’

MPK

MPK* MPK

MPK*

10 9 8 7 6 5 4 3 2 1

Microeconomics of Capital Market Integration

r’

r0*

r0

r’

K0 K0* K0+K0*

K’

MPK

MPK* MPK

MPK*

C D FMPK

MPK*

MPK*

MPK

MPK

r0

r’

r0*r’

BA

p p’

K’

K0 K0* K0+K0*

Total Gains = B + C

G H

IJ

C D FMPK

MPK*

MPK*

MPK

MPK

r0

r’

r0*r’

BA

p p’

K’

K0 K0* K0+K0*

Total Gains = B + C

G H

IJ

Welfare Effects of Capital ‘Migration’

• Capital owners in home country (the one on the left): initially they had A+G, but now G+C+D+E.

• Laborers in home country: initially had J, but now have J+A+B.

• Effect on home: ((G+C+D+E)-(A+G))+((J+A+B)-(J)) = C+D+E-A+A+B=C+D+B+E

• Analogously, effect on foreign country = ((F+H)-(E+H))+((I)-(I+D+F))=F-E-D-F=-E-D

• Total effect = C+B.

Labour Market Integration: Simplest Framework

Labour Market Integration: Simplest Framework

Labour market integration

Labour market integration

• The same analysis applies as before: welfare increases by B+C.

Growth Effects

• European leaders have long emphasised the pro-growth aspects of European integration.

• These operate in a way that is fundamentally different from the way allocation effects operate (these refer to the effects we considered last week).

• They operate by changing the rate at which new factors of production – mainly capital – are accumulated, i.e. 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.)

Verbal Logic of Growth

• Therefore, 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 → Better investment climate → More investment in machines, skills and/or technology → Higher output per person.

• Medium run effects eventually peter out

• Growth returns to its long-run rate.

Some FactsEuropean Growth Phases, 1890-1992

Solow Diagram

• Show medium run growth effects in simple diagram.

• To simplify, start with whole EU as a single, closed economy with fully integrated capital and labour markets and the same technology everywhere.

Solow Diagram

Induced Capital Formation

Integration Induced Investment Rate Rise

Long-Term Growth in Solow-Like Diagram

Long-Term Growth Impact of Integration

K/L =Knowledge/L

euros/L

GDP/L

s(GDP/L)

δ(K/L)

Y/L*

K/L*

B

A

s’(GDP/L)

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

C

Next Week

• Optimal Currency Area Theory

• Theory + Critique of OCA