Regionalism in Europe
Geometries and Strategies after 2000

A conference on ‘Regionalism in Europe: Geometries and Strategies after 2000’ was held on 6/7 November, 1998 at the Zentrum für Europäische Integrationsforschung (ZEI) in Bonn. The conference was organized jointly by CEPR, the Yrjö Jahnsson Foundation (Finland) and ZEI. The organizers were Jürgen von Hagen (ZEI, Universität Bonn, and CEPR) and Mika Widgrén (Yrjö Jahnsson Foundation, University of Helsinki, and CEPR).

The first conference session, on ‘Theoretical and Institutional Issues’, comprised three papers. ‘Federalism with Overlapping Jurisdictions and Variable Levels of Integration: The Concept of FOCJ’, was presented by Bruno Frey (Universität Zurich) and was a joint work with Reiner Eichenberger (Universität Zurich). The authors outlined their concept of functional, overlapping, competing jurisdictions (FOCJs). Such jurisdictions would each have their own powers of enforcement and taxation, would be designed separately for each function or task, would compete for members and, owing to the multiplicity of tasks, would overlap each other with regard to geographical area. The size and structure of each unit would be determined endogenously by the members. The authors evaluated the benefits of the concept and related it to past and present experience. They viewed the FOCJ as a mechanism for achieving a more democratic and efficient form of federalism, able to cope with future challenges, such as the integration of Central and Eastern European countries into the EU. They argued that the right to create such FOCJs should be included as a fifth freedom in any future European constitution.

Hans-Peter Grüner (Universität Bonn) thought that more formal research was needed to determine whether such a proposal to develop a new type of federalism would be helpful. He was sceptical about the value of FOCJs as a solution to problems of redistribution, free-riding jurisdictions and tendencies towards regional hegemony. On the contrary, he thought that the concept might well lead to additional problems, such as a ‘supervision paradox’ in the case of cross-border FOCJs, with an even stronger role for Brussels. Carl Hamilton (Svenska Handelsbanken and CEPR) argued that the scheme would not be characterized by free mobility, since if any individual was not liked by the group they wanted to enter, entry would be impossible. It was also unclear what roles would be left for political parties to play under FOCJs. Alan Winters (World Bank and CEPR) foresaw a problem of instability on account of changes in membership and wondered whether, in the absence of an a priori definition of focus of a FOCJ, there was not scope for groups to behave opportunistically. Bernd Hayo (University of Bamberg, ZEI, and Universität Bonn) saw a potential problem of lack of solidarity in FOCJs compared to (say) neighbourhood solidarity, and wondered whether the disadvantages of structuring the organization of a firm by function might not apply also to government.

In ‘Agenda Setting, the Rules of the Game and Optimal Integration’, Mika Widgrén (Yrjö Jahnsson Foundation, University of Helsinki, and CEPR) developed a decision-making model based on a non-cooperative game in a principal-agent setting, involving national governments as agents and a supranational player as the principal. Widgrén focused on the optimal and efficient design of an integration treaty, concentrating primarily on the decision-making rules to be laid down and applied. The results depended on whether there was perfect information or whether national agents had an informational advantage as regards national preferences. He concluded that, under perfect information and common policies, there was a trade-off between ex ante optimality and ex post efficiency, with the result that only unanimity rules were efficient ex post. Under a flexible integration scheme, however, in which decision-makers could choose between a common policy adopted by a pre-defined majority and an alternative (the ‘zero integration case’), both ex ante optimality and ex post efficiency could be achieved.

Reiner Eichenberger considered that the model did not lead to any testable prepositions. Given that more complex models might prove intractable, he suggested starting with analysis of the important aspects of integration first and proceeding further only if this exercise identified something that was worth modelling. Alan Winters and André Sapir (ECARE, Université Libre de Bruxelles, and CEPR) wondered whether such a super-institution was really necessary for integration, with Sapir adding that it depended on the degree of integration. In the case of EFTA, for example, the free trade agenda was already given, so the only additional requirement was for an enforcement mechanism. Jürgen von Hagen noted that the model offered no scope for spontaneous formation of FOCJs, which implied that Frey and Eichenberger should think about the effect of asymmetry in information and uncertainty on their concept.

‘Inequality and Convergence: Reconsidering European Regional Policies’, was presented by Michele Boldrin (Universidad Carlos III, Madrid, and CEPR), and co-authored by Fabio Canova. The authors’ aim was to interpret, in the light of convergence concepts in economic growth, their finding that regional economic inequality – measured in terms of per-capita income, unemployment and labour productivity – had not decreased in the European Union during the last 15 years. Analysis of three special data sets for Spain, Italy and Greece, had led the authors to their belief that regional and structural policies served mostly a redistributive purpose and had little positive impact on economic growth. They acknowledged, however, that their testing had been indirect at best and that their results should be regarded as preliminary, since serious evaluation of the impact of current policies was limited by the lack of reliable and comparable official data on investments of structural funds.

Eckhardt Bode (Institut für Weltwirtschaft, Kiel) suggested that, in the absence of a control group – consisting of comparable poor regions in the EU that did not receive funds – the authors might look at regions/countries (such as Ireland) where convergence had happened for the probable causes of convergence, and to ask whether EU support had been helpful. Bode was critical of the value of modern economic growth theory which, for reasons of simplicity, always neglected important factors, and he wondered what a proper definition of divergence – as opposed to the convergence principle applied in the paper – would look like. For Dalia Marin (Universität München and CEPR) the non-convergence results were unsurprising, from both a theoretical and an empirical perspective. New growth theory would not necessarily predict convergence, given the limited mobility of production factors and the large role played by trade; and time-series tests typically did not point to convergence, whereas cross-country tests did. On this point, Michele Boldrin considered that Barro had been wrong to ignore the time dimension. Michael Hutchinson (University of California, Santa Cruz, and Copenhagen Business School) considered the time frame altogether too short, as a growth process was often discrete and was much slower to converge than (say) price levels.

There were four papers in the session on ‘Trade’. In ‘Trade Regionalism in Europe: Towards an Integrated Approach’, André Sapir (ECARE, Université Libre de Bruxelles, and CEPR) focused on the network of 93 European Regional Trade Agreements (RTAs) in existence in 1998, apart from the EU, EFTA, CEFTA (the Central European Free Trade Area) and BFTA (the Baltic Free Trade Area). Sapir explored the evolution of these RTAs since 1960 and the problems to which they had given rise, extending Richard Baldwin’s 1994 study of the same topic. Sapir identified the driving force of integration as a ‘domino effect’ in terms of which increased integration within a RTA generated negative consequences for non-members, prompting them to apply for membership. He addressed the problems faced by the current ‘pan-European trading architecture’ – which he described as a ‘hub-and-spoke system’ of bilateral RTAs with the EU as the focal point – and suggested different solutions to these problems.

Jürgen von Hagen commented that, even when taking the regressions at face value, Sapir’s analysis was not really addressing welfare effects, such as trade creation versus trade diversion and whether the multiplicity of agreements was really an issue considering that there were 40 heterogeneous countries in Europe. There was also the question of whether the focus was on a static equilibrium situation or a dynamic process. Carl Hamilton argued that, although the multiplicity of free trade agreements might be a good thing, the current system did not involve negotiations between equal partners – a point clearly illustrated by the EU’s exclusion of sensitive goods. Alan Winters wondered whether the solution originally proposed by Baldwin was even WTO-compatible. Giorgia Giovannetti (European University Institute, Firenze) suggested that the different exchange-rate systems should also be taken into account when looking at the domino effects.

Alan Winters (World Bank and CEPR) presented ‘Post Lomé Trading Arrangements: The Multilateral Option’, in which he expanded on his previous research on the FTA route out of Lomé. Winters considered that the preferential access that would be granted to EU goods under the projected FTAs in a new Lomé agreement would probably be economically harmful to the ACP countries because of trade diversion effects and loss of tariff revenues. Since the benefits to be obtained from North-South FTAs were far from clear, but were no less likely to be achieved under multilateral arrangements, he made the case for solving the Lomé ‘problem’ multilaterally within the WTO.

Azefa Admassie (Addis-Ababa University and Centre for Development Studies, Bonn) argued for closer examination of the compatibility of trade reforms with other reforms, especially bearing in mind the objectives of poverty reduction and enhanced development. Carl Hamilton wanted to know how important the loss of tariff revenues would be for the ACP countries if their imports from the EU rose. He also pointed to the difficulties and costs being borne by ACP countries in redirecting manpower to the Lomé renegotiations. Denise Eby Konan (University of Hawaii) thought there was a need to reassess comparative advantage for (some) Lomé countries in the light of their actual export figures.

Bernard Hoekman (World Bank and CEPR) presented ‘Deep Integration, Regionalism and Nondiscrimination’, co-authored with Denise Eby Konan (University of Hawaii). The authors defined deep integration as ‘explicit actions by governments to reduce the market segmenting effects of domestic (non-border) regulatory policies’, and they investigated its potential importance for Egypt in the context of trade agreements with the EU, employing a general equilibrium model.

Giorgia Giovannetti noted that the authors’ model and simulations were limited to the static gains from trade liberalization, but that the dynamic effects – not just those on trade, but also those on creditworthiness and foreign investment – seemed more important. Erinc Yeldan (Bilkent University, Ankara) also argued for consideration of the dynamic effects, pointing to the limited effects of the changes suggested in the paper. Michael Rauscher (Universität Rostock and CEPR) asked whether it would be possible to disaggregate the numbers further by looking at the sector-specific effects of non-tariff barriers.

In her paper, ‘On the Long-Run Effects of Expanding Regionalism’, Caroline Freund (Federal Reserve System) examined the long-run impacts of expanding regionalism, if free trade afforded the original members first-mover advantage in their partners’ markets. According to the model, expanding regionalism leads to a higher welfare level for the original members, compared to multilateral free trade, and a lower welfare level for original non-members and higher world welfare during the second period. Looking at data for the EU, Freund regarded the empirical evidence as consistent with the model.

Uwe Walz (Universität Tübingen and CEPR) said that, in the model, regionalism could be regarded as an investment in market share, introducing permanent asymmetries between otherwise perfectly symmetric countries. Both the argument and the model, however, had their limitations. On the welfare effects, he thought it necessary to look at how long the postulated advantages were likely to persist, which required understanding of the underlying microeconomics. Furthermore, all the usual objections against rent-shifting models would apply to the current setting of a partial-equilibrium model with its factor-endowment constraint. In addition, the model was less applicable to developing countries, and if major markets were dispersed, regionalism became less attractive as well. Alan Winters suggested using a gravity model with proper panel investigations to test the empirical implications, and Hans-Peter Grüner suggested there might be a severe problem of multicollinearity in Freund’s model, as it might appear that income mattered if rich countries entered the regional arrangements first. Michael Hutchinson thought a permanent effect doubtful, given market dynamics, with new markets and technologies emerging. In contrast, Carl Hamilton thought there was an argument for the permanent discrimination case, considering that latecomers had to accept the rules of the game in Brussels (which was why he found the results so distasteful).

The session on ‘EMU’ began with ‘Nordic Integration and European Integration’, presented by Thorvaldur Gylfason (University of Iceland, SNS, Stockholm, and CEPR). The author concentrated on the implications of EU integration for the Nordic countries, which differed in their current relationships with the EU. Data comparisons, which included the role of the primary sector in these countries, confirmed the lack of homogeneity in their economic structures. The paper also highlighted both the problems and possible policy solutions for Iceland and Norway as the two countries with the highest primary-sector dependency.

Pertti Haaparanta (Helsinki School of Economics and Business Administration) challenged some of Gylfason’s data, quoting Penn data which showed both the Finnish investment-to-GDP ratio and the growth rate to be among the highest in the world. He argued that the political-economy argument had to be constructed more carefully, and that it was necessary to enquire into the reasons for the different speeds of integration with the EU. Jürgen von Hagen was also sceptical about Gylfason’s interpretation of the effects of natural-resource dependency: Latin American countries had decreased their primary-sector dependency in the last 20 years, but this had been at the cost of a worsening in their income rankings. Carl Hamilton thought the analysis should focus more on growth and welfare rather than being preoccupied with exports. Torben Andersen (Aarhus Universitet and CEPR) wondered whether it was right to disparage the primary sector in general, since it often comprised high-tech activities. A complicating factor, however, was that EU integration implied increased regulation for the sector. To evaluate whether the manufacturing sector fared better than the primary sector, he suggested a comparative look at their exports.

Michael Hutchinson (University of California, Santa Cruz, and Copenhagen Business School) presented ‘Northern Light: Do Optimal Currency Area Criteria Explain Nordic Reluctance to Join EMU?’ This paper, which was co-authored by Michael Bergman, concluded that optimal currency area (OCA) theory could neither explain why Denmark, for example, as a ‘core’ country, had opted to stay out of EMU, nor why Finland – a non-core country – had opted in. From a more forward-looking perspective, however, the Finnish decision was less surprising. The authors similarly concluded that political-economy arguments did not suggest that the lack of Nordic enthusiasm for EMU could be ascribed to an excessively ‘conservative’ institutional design for the ECB.

Torben Andersen agreed that the forward-looking economic argument was more appropriate than the static concepts underlying the OCA model, but that political considerations were really the most important factor in such decisions. This was true in Denmark, for example, where people were afraid that their ‘sense of being different’ would be compromised by their incorporation into the EU, and where the size and structure of the public sector and the nature of labour-market policies and institutions were relevant issues. Carl Hamilton, however, reminded participants that political decisions often were influenced by economic events: for example, it could be argued that the main reason Sweden had voted to join the EU was that it feared the economic consequences of not joining. Although accepting that such preferences were important, Bruno Frey noted that the authors had shied away from looking directly at preferences, for which they could have made use of Eurobarometer survey data. He suggested building a full-scale political model. Jürgen von Hagen proposed that elements of risk aversion be incorporated in the model in order to determine the optimal time of entry, given that the reticence of some countries could be explained by a wait-and-see attitude based on a desire to see how the various institutions and policies would develop.

In ‘Europe’s Outsiders and their Challenges with EMU’, Andreas Fischer (Swiss National Bank and CEPR) surveyed the monetary-policy challenges posed by EMU for six outsiders, namely Denmark, Iceland, Norway, Sweden, Switzerland and the United Kingdom. Fischer paid particular attention to recent and potential changes in the overall framework of monetary policy, the current state of macroeconomic conditions in the EU-11, and shifts in credibility experienced since the declarations of intent by EMU participants in May 1998.

Kari Alho (The Research Institute of the Finnish Economy and University of Helsinki) suggested looking more at ‘interdependencies’, such as whether Finnish participation made it easier or harder for other Nordic countries, and whether Sweden might be a free rider in EMU through its links with Finland. It was also important to examine the goals of the ‘outs’: might Sweden, for example, not just be a ‘pre-in’ with its decision dependent on whether the United Kingdom entered? Giorgia Giovannetti was surprised to find no reference to the international role of the currencies of the ‘outs’, and the effects of the seignorage losses that would be incurred if they were replaced. Torben Andersen argued for consideration of contagion effects, which might become even more important with the Nordic countries following different exchange-rate rules. Michael Hutchinson suspected that interest-rate differentials were caused by expectations of inflation differentials, as markets otherwise would appear irrational.

The topic of the last conference session was ‘Central and Eastern Europe’. Klaus Wallner (SITE, Stockholm School of Economics) presented ‘Leverage over Applicants: The Strategic Use of EU Accession’, a paper co-authored by Erik Berglöf. The authors presented a model of the strategic aspects of the decision on whether to ‘join a club’, the context here being Eastern enlargement of the EU. One key element was the trade-off between late accession, which could be used to foster reforms in applicant countries, and the cost of the withholding of the financial transfers to applicants that would come with accession and would relieve their financial constraints in inducing reforms. The model was used to examine several issues central to the enlargement debate, including internal EU reforms, the absorption capacity for reforms in applicant countries, and imperfect information.

Pekka Sutela (Bank of Finland) thought the conclusions were sometimes too simple, and wondered whether the two-period model could adequately explain the dynamic aspects of the problem. He argued that issues both of credibility and of public goods might well be more important for potential members than the funding issue emphasized in the model. Caroline Freund remarked that there was a time-inconsistency problem in the model, if reforms undertaken by applicants were irreversible.

Erinc Yeldan (Bilkent University, Ankara) presented ‘Turkey’s Strategic Trade Policy Alternatives in a World of Multi-Polar Trade Blocs: Lessons from an Intertemporal, Multi-Region General Equilibrium Model’, written together with Xinshen Dao. The authors’ model embraced issues of trade liberalization, growth and capital accumulation in the context of a world economy moving towards a multipolar structure. Focusing on the Middle East, Turkey, the EU and the economies in transition, under various alternative scenarios of customs-union formations, they concluded that increased bilateral trade between these regions held out the prospect of significant gains.

Matthias Luecke (Kiel Institut für Weltwirtschaft) noted the special institutional framework of the Turkey-EU customs union in which the EU and Turkey remained separate customs areas with no delegation of sovereignty involved. The advantage of Yeldan’s model was that it included dynamics, but other important integration effects and possible sources of benefit for Turkey – such as increased credibility of domestic reforms – were absent. On the determination of the optimal size of the RTAs, he suggested exploring Sapir’s proposal for a pan-European FTA, including all of Central and Eastern Europe, which would offer Turkey more profitable access. Bernard Hoekman argued for quantification of the benefits.

The last paper of the conference was ‘Visegrad Integration as a Strategy for EU Accession’, presented by Kalman Dezseri (Institute of World Economics, Budapest). The paper provided a detailed account of the development, and of the political and economic roles, of Visegrad cooperation, which recently had  been revitalized by a meeting between the prime ministers of the Czech Republic, Hungary and Poland. The author claimed that, since these were relatively poor countries with little influence, not too much should be expected from integration. Although Visegrad cooperation might be seen as a step towards the ultimate goal of integration with the EU, which would replace the market previously provided by the former Soviet Union, there were also a number of problems to be confronted. Some of the problems stemmed from historical factors, some were due to different levels of development, some to the different routes chosen in the transition to a market economy, and some were related to the question of Poland’s potential domination of the group.

In asking for more specific data on the countries, Dalia Marin thought that Dezseri’s view of the potential dangers and benefits of regional integration was too negative. She suggested that alternative models – such as the one presented earlier by Caroline Freund – showed that regional cooperation could provide clear benefits. It was arguable, moreover, that less-developed countries should first integrate with countries at similar levels of development, in order to gain time to build up their human capital and technology sectors. The benefits of this strategy did not necessarily compare unfavourably with the opportunity costs of not integrating first with a richer region which offered immediate exploitation of knowledge spillovers. Klaus Wallner also thought there might well be advantages in the small countries first building up their infrastructure. Jürgen von Hagen said that the objection against Visegrad integration was based on the idea of strong hysteresis in industry structure – an argument which did not seem clear to him. Moreover, the Visegrad countries found themselves as price-takers facing trade-distorting prices. Visegrad integration would be a good thing, none the less, because it implied a reduction of trade barriers and would strengthen the countries’ position in negotiations with the EU. Alan Winters took the opposing view on the issues of the hysteresis of industry structure and price-taking by the Visegrad countries.

The conference had begun by discussing matters of institutional design, some of them connected to the concept of ‘deepening’ the EU. Among the suggestions had been the new and quite radical concept of FOCJs as a means of acieving a more democratic and efficient form of federalism, but the need to look at the EU’s existing regional policies had also been noted. Subsequently, discussion had focused on trade-related topics, especially RTAs and their theoretical and policy implications, before moving on to consideration of EMU and the situation of the ‘outsiders’, particularly the Nordic countries. Finally, the conference had dealt with issues raised by the proposals to ‘widen’ the EU to incorporate Central and Eastern European countries. The conference had therefore succeeded in covering a broad range of issues relevant to the future of regionalism in Europe.