the economics of european integration

© Baldwin & Wyplosz 2006

The Economics of European Integration


Chapter 6

Market Size and Scale Effects


Market Size Matters• European leaders always viewed integration as

compensating small size of European nations.– Implicit assumption: market size good for economic

performance.

• Facts: integration associated with mergers, acquisitions, etc.– In Europe and more generally, ‘globalisation.’


Facts

• M&A activity is high in EU.

• much M&A is mergers within member state.– about 55% ‘domestic.’– Remaining 45% split between:

• one is non-EU firm (24%), • one firm was located in another EU nation (15%),• counterparty’s nationality was not identified (6%).


Facts• Distribution of M&A

quite varied:– Big 4: share M&As much

lower than share of the EU GDP.

– I, F, D 36% of the M&As, 59% GDP.

• Except UK.

– Small members have disproportionate share of M&A.

M&A activity by nation, 1991-2002

B, 2.8%

DK, 2.6%

EL, 1.1%

E, 5.0%F, 13.5%

IRL, 1.7%

I, 6.2%

L, 0.5%NL, 6.5%

A, 2.1%

P, 1.2%

FIN, 3.9%

S, 5.3%

UK, 31.4%

D, 16.3%


Facts

• Why M&A mostly within EU?

• Why UK’s share so large?– Non harmonised takeovers rules.

• some members have very restrictive takeover practices, makes M&As very difficult.

• others, UK, very liberal rules.

• Lack of harmonisation means restructuring effects very impact by member states.


Theory: Economic Logic Verbally

• liberalisation

• de-fragmentation

• pro-competitive effect

• industrial restructuring (M&A, etc.)

• RESULT: fewer, bigger, more efficient firms facing more effective competition from each other.


Economic logic: background

Sales

Price

MarginalCost

Marginal RevenueCurve

DemandCurve

Sales

Price

Q’+1

P”

MarginalCost Curve

C E

D

DemandCurve

A

B

Q*Q’

P*P’

Monopoly case


Duopoly case, example of non-equilibrium

Residual Demand Curve firm 2 (RD2)

Firm 2’s expectation of sales by firm 1, Q1

DemandCurve (D)

MC

Residual Marginal Revenue Curve firm 2 (RMR2)

x2’

p2’

Firm 2 sales

Residual Demand Curve firm 1 (RD1)

Firm 1’s expectation of sales by firm 2, Q2

DemandCurve (D)

price

MC

Residual Marginal Revenue Curve firm 1 (RMR1)

x1’

p1’

Firm 1 sales

A1 A2

price


Duopoly & oligopoly case, equilibrium outcome

RD’

D

MC

x**

p**

sales

A

price

RMR’

3x**Oligopoly

RD

Typical firm’s expectation of the other firm’s sales

D

MC

x*

p*

sales

A

price

RMR

2x*

Duopoly

Typical firm’s expectation of other the other firms’ sales


BE-COMP diagramMark-up ()

COMPcurve

BE (break-even) curve

’

n’

mono

duo

n=1 n=2 Number of firms


Details of COMP curve

Marginal cost curve

Typical firm’s sales

price

p"

Monopoly mark-up

Duopoly mark-up

D

R-D (duopoly)

xmonoxduo

MR (monopoly)R-MR

MC

p'

AB

A’

B’

Mark-up

Number of firms

COMPcurve

n=1 n=2

mono

duo


Details of BE curve

Sales per firm

AC

price

Totalsales

Co

Demand curve

Number of firms

Mark-up (i.e., p-MC)

o

xo= Co/no

MC

euros

BE

no

AC>po

AC<po

poo+MC

x’= Co/n’ x”= Co/n”

A

B

B Apo

ACo=po

n” n’

Home market


Equilibrium in BE-COMP diagram

Sales per firm

AC

Price

Totalsales

Demand curve

Number of firms

Mark-upeuros

x’

COMP

BE

n’

C’

E’p’E’ E’

'p’

MC

Home market


No-trade-to-free-trade integration

Sales per firm

AC

price

Totalsales

Demand curve

Number of firms

Mark-upeuros

x’

COMP

BEFT

BE

2n’

x”

n” n’

E’

E”

C’ C”

E’

A

1

E”

A

MC

p”

p’

pA

'

A

p”

p’

Home market only

E”

E’

C


Economic Logic• Integration: no-trade-to-free-trade: BE curve shifts out (to point 1).• Defragmentation:

– PRE typical firm has 100% sales at home, 0% abroad; POST: 50-50 ,– Can’t see in diagram.

• Pro-competitive effect: – Equilibrium moves from E’ to A: Firms losing money (below BE).– Pro-competitive effect = markup falls.– short-run price impact p’ to pA.

• Industrial Restructuring:– A to E”,– number of firms, 2n’ to n”. – firms enlarge market shares and output, – More efficient firms, AC falls from p’ to p”, – mark-up rises, – profitability is restored.

• Result: – bigger, fewer, more efficient firms facing more effective competition.

• Welfare: gain is “C”.


Competition & Subsidies• 2 immediate questions:

– “As the number of firms falls, isn’t there a tendency for the remaining firms to collude in order to keep prices high?”

– “Since industrial restructuring can be politically painful, isn’t there a danger that governments will try to keep money-losing firms in business via subsidies and other policies?”

• The answer to both questions is “Yes”. • See Chapter 11, 2nd Edition.

the economics of european integration

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