Recent issues of the Bulletin have reported the results of several research programmes on the consequences of the completion of the internal market in 1992. Existing estimates of the effects of market integration remain very preliminary, however, and many important issues have yet to be adequately addressed. These include, for example, the effects of integration on internal EC technology and taxation policies and the consequences of these policies, the implications of `1992' for the Community's trade with both its traditional EFTA partners and the potentially valuable new East European markets, and the possible effects of international trade in general on intra-EC trade, in particular how this may promote or hinder the realization of the predicted gains.
Many of these issues were discussed at a conference on `The Impact of 1992 on European Trade and Industry', held by CEPR, the Centro Interuniversitario di Studi Teorici per la Politica Economica, and Confindustria, at Urbino, Italy, on 15/16 March 1990. The conference was organized by L Alan Winters and Anthony Venables, respectively Co-Director of and a Research Fellow in CEPR's International Trade programme, and Stefano Micossi of Confindustria. CEPR is grateful to Ente Nazionale Idrocarburi for the use of its conference facilities, and to the UK Department of Trade and Industry and Foreign and Commonwealth Office for the financial support provided as part of the Centre's research programme on The Consequences of `1992' for International Trade. This research is also funded by the Commission of the European Communities under the SPES programme.
The Gains from Integration
Anthony Venables (University of Southampton and CEPR) presented a paper on `Completing the Internal Market in the European Community: Factor Demands and Comparative Advantage', written jointly with Michael Gasiorek and Alasdair Smith, in which they employed a general equilibrium approach to analyse the consequences of 1992 for output, factor demands and factor prices. They considered five EC `countries', plus the `rest of the world', where each country is endowed with capital and three types of labour. The manufacturing sector is divided into a `numeraire' (perfectly competitive, composite) sector and 13 manufacturing industries, which are all assumed to exhibit increasing returns to scale in an imperfectly competitive environment.
Their results showed that the output changes consequent on 1992 will result in increased demand for skilled labour relative to unskilled, but that the effects on factor prices will depend on the relative factor intensities of the numeraire sector and the manufacturing industries. According to their model, in France, West Germany and the UK, `professional and scientific' labour will experience the largest relative increase in demand, while in Italy and the `rest of the EC', `other non-manual' workers will experience the largest increase. For example, they estimate that the completion of the internal market will cause the real wages of `professional and scientific' workers in the UK and France to rise by 0.65% and 0.43% respectively, while the corresponding figures for `other non-manual' workers are predicted to fall by 0.17% and 0.13% respectively.
In the discussion that followed Paul Brenton (University of Wales, Bangor) and John Whalley (University of Western Ontario) suggested that it would be desirable to distinguish between the gains due to the pro-competitive and rationalization effects of market integration. Whalley also noted that the welfare effects had not been computed in the model, while Brenton suggested that since the estimates for the `rest of the Community' were consistently larger than for the individual countries, a further disaggregation, and in particular a North-South distinction, would be useful.
In a paper on `External Effects and Europe's Integration', written jointly with Ricardo Caballero, Richard Lyons (Columbia University) examined the possibility that firms may gain from external economies of scale over and above the internal economies that are widely expected to follow from 1992 (as measured by Gasiorek, Smith and Venables, for example). Since the use of aggregate EC data would bias the measurement of external returns to scale by internalizing any country-specific external returns, Caballero and Lyons used national data to determine whether any such international external effects exist in addition to the purely national external effects detected in their own previous studies of the US and of individual European economies.
They found that a 1% increase in the average level of economic activity as a result of the completion of the internal market will yield an additional dividend to integration of only 0.1% as a result of these external effects. These results do not necessarily imply that the European Commission's estimates of the gains from 1992 are too low, however, since the disaggregate estimates of internal increasing returns to scale used in this model are lower than those used by the Commission. Hence the direct effects of 1992 on economic activity may be lower than expected, in which case the indirect external effects
will have only smaller output effects to magnify.
In the discussion that followed, Alasdair Smith (University of Southampton and CEPR) raised doubts about the robustness of the results and suggested that they might be attributed to various factors. In particular, errors of measurement at the aggregate and two-digit levels of manufacturing or an inappropriate choice of instrumental variables could be sufficient to generate the differences in the observed elasticities. Other participants suggested that these international and national effects could be attributed to factors such as the international transmission of productivity shocks and pro-cyclical business start-ups. In reply Lyons said that the instruments employed were relatively robust and that the measurement error problem could not be large enough to generate the observed results.
Internal Effects of External Competition
Most research into European integration to date has ignored the influence of world trade on the behaviour of European producers. Riccardo Faini (Johns Hopkins University) and Alberto Heimler (Confindustria) presented the first of two papers on these issues: `The Multifibre Agreement and the Quality of Production of Textiles and Clothing after 1992'. They focused on how EC producers might make a `strategic quality choice' for their products in order to take advantage of the barriers to trade with the EC that third-country producers will continue to face. Thus their paper relates closely to the issues of protection and quality choice by exporters facing trade restrictions, which have received considerably greater attention in the literature. They studied the `quality response' of the Italian textile and clothing industries, which are protected against imports from developing countries by the Multifibre Arrangement.
Their results showed that any combination of quality increase or decrease for domestic and foreign supplies may be generated, depending on the assumptions made about the cross- effects of quantity and quality on costs and the prices consumers are willing to pay. More specifically, for imports of textiles and clothing from 17 countries to the four major EC markets for the period 1982-7, Faini and Heimler estimated that the quality differences within each market explained around half the difference in the unit values for the different exporting countries. They also found that developed countries generally supplied lower-quality textiles over the whole period, and that their quality displayed no clear trend, whereas there was a strong trend for the quality of clothing to improve, which was noticeably stronger in developing than in industrial countries.
In the discussion that followed, the participants noted the difficulties in measuring quality responses of this type, and of distinguishing among price movements resulting from changes in quality, trade restrictions, and income growth and exchange rate movements. Carl Hamilton (Institute for International Economic Studies, Stockholm, and CEPR) also noted that quality responses will also depend on the market structure of the protected economy.
The Community's external trade may also have wider effects on firms' behaviour. André Sapir (Université Libre de Bruxelles and CEPR) presented a paper on `The Discipline of Imports in the European Market', written jointly with Alexis Jacquemin, in which they considered the conflicting influences of the scale economies to be realized as a result of integration and the anti- competitive effect to be expected as the number of firms competing in each country falls, and the importance of EC competition policy in obviating this anti-competitive force. Actual or potential imports from outside the Community may serve to reduce EC firms' market power, thus reinforcing the pro- competitive effect of integration and possibly providing an alternative to explicit competition policy.
They related price-cost margins to intra-EC import penetration, extra-EC import penetration and a set of variables characterizing industrial structure, for over 100 industries in each of the `Big-Four' EC countries. Only extra-EC imports exerted any significant disciplinary effect on price-cost margins. They found, however, that non-tariff barriers (NTBs) to intra-EC trade protect EC producers by restricting trade in goods originating outside the Community, and they concluded that the EC should seek increased freedom of world trade in the Uruguay Round. Sapir cautioned, however, that if a small number of foreign firms were to dominate EC sales, then the liberalization of external trade could have a perverse effect, in which case strong competition policy would still be necessary.Much of the discussion focused on econometric issues, in particular the difficulties in accounting for the influence of capital intensity on industries' reported profit margins, interpreting the internal and external trade coefficients, and measuring the effects of NTBs. Damien Neven (INSEAD and CEPR) said that reducing NTBs to internal trade would be of greater benefit to non-member than to member countries, since they were more severely affected by the restrictions as they stand at present.
Market Integration and the Rest of Europe
The Community currently has several treaties with non-EC European countries governing their access to the EC market, which are under review in the light of the forthcoming full integration of the internal market. Several of these countries have applied for membership of the Community, and the review process is further complicated by the changing political and economic situation in Eastern Europe. The arrangements that will govern East-West trade in the future are of particular concern to the southern members of the Community, which are widely perceived to have a similar pattern of comparative advantage to the East European economies (specializing in the production of low-skill, labour-intensive and agricultural goods). If this perception is broadly correct then the southern members' expected gains from 1992 might be diminished if Eastern Europe is granted significant trading concessions. If on the other hand East-West trade is principally of an intra-industry nature, then there is potential for them to make even larger gains.
Damien Neven (INSEAD and CEPR) and Lars-Hendrik Röller (INSEAD) presented a paper on `European and EC Integration', in which they sought to determine whether this widespread perception of Eastern Europe's comparative advantage is valid by assessing the economic rationale underlying the existing pattern of East-West trade. They provided a descriptive analysis of the trade flows between Comecon countries and a sample of Western countries (including EC and EFTA countries, Japan and the US) in terms of size, direction and commodity content. They reported the results of a preliminary econometric study of the net trade between the `Big-Four' EC countries and Comecon for 29 manufacturing industries over the period 1975-87. The model included explanatory variables that were chosen to represent both inter-industry and intra-industry determinants of trade as well as trade barriers.
Their results showed little evidence of significant trade based upon traditional patterns of comparative advantage, but displayed strong evidence of intra-industry trade in both capital-intensive and human-capital-intensive sectors. They therefore concluded that the southern members of the Community should have little to fear from the increase in East-West trade in the run-up to 1992. Neven and Röller emphasized, however, that their results were all predicated on the hypothesis that the current pattern of East- West trade reveals the true pattern of comparative advantage between East and West, despite having been managed by the central authorities in Eastern Europe throughout the post-war period.
In the ensuing discussion, many participants questioned the validity of this assumption and hence the value of the trade statistics currently available. Fabrizio Onida (Università Bocconi, Milano) pointed out that 70% of East-West trade was in non- manufactured products and that energy prices were by far the most important determinant of the level and the pattern of Comecon countries' trade. Onida also noted that certain components of trade viewed by Neven and Röller as intra-industry trade in fact involved products with different energy intensities, and were therefore consistent with traditional patterns of comparative advantage.
In a paper on `1992 and EFTA', Victor Norman (Norwegian School of Economics and Business Administration, Bergen, and CEPR) analysed the dilemma faced by the small, open EFTA countries in their negotiations with the EC about mutual trade arrangements or full membership. Their smallness suggests the potential for significant gains from unrestricted access to an integrated market, while their existing openness and reliance on comparative advantage suggest the possibility that most of the gains that might be expected from integration have in fact already been achieved.
Focusing particularly on Norway and Sweden, Norman reported a number of empirical estimates of the scale economies and competitive gains to EFTA from the integrated market, the extent of unexploited comparative advantage between the EC and EFTA, and the losses to EFTA from a more protectionist external policy. His results suggested that modest scale economies and competitive gains are to be expected in manufacturing, and much larger potential gains in services. As regards comparative advantage, wage differentials between EC and EFTA countries are so small that 1992 should have little effect on the broad pattern of inter-industry specialization, although there may be substantial gains at the level of individual industries. Finally, he found that while a more protectionist external trade policy could significantly dampen the gains to EFTA from integration, it would certainly not reverse them.
Carl Hamilton, John Whalley and Peter Holmes (University of Sussex) questioned whether a new bilateral EFTA/EC trade agreement of the type currently proposed was necessary for the EFTA members to enjoy the benefits of free trade with the Community, and suggested that the search for such an agreement may owe more to fears about access to EC markets in the longer term and EC competition policy than to the debate over immediate gains and losses. Norman agreed with this view, and pointed out that most of the gains concerned were home country gains which individual countries could derive unilaterally. Thus, he suggested that the proposed trade agreement was primarily concerned with problems of political economy and with providing a constitutional bulwark for EFTA governments against domestic protectionist pressures.
Whalley noted in particular that the agricultural policies of many EFTA countries were even more protectionist than the CAP, and suggested that such a trade agreement might help their governments to impose a degree of discipline on their agricultural sectors. Norman replied that the gains to EFTA from the abolition of its own agricultural support would be even greater than those to be obtained from joining the CAP, so that EFTA's agricultural sectors were in favour of joining the Community in order to protect themselves from even more severe cuts in domestic subsidies.
The Dynamic Effects of `1992'
In static terms the principal aim of completing the internal market in 1992 is to remove the remaining barriers to the free movement of goods and factors in order to realize the gains of the type described by Gasiorek, Smith and Venables above. It is hoped, however, that increased competition and market integration will also enhance the EC's dynamic efficiency by providing a larger market in which to develop new products, obtain technological advances and promote new research and development ventures generally. Such dynamic effects will be significantly affected by the EC's policies on technology, corporate taxation and foreign investment.
David Ulph (University of Bristol and CEPR) presented a paper on `Technology Policy in the Completed European Market', in which he focused on the dynamic gains to be expected from the EC's increased potential for technological advance, by presenting a theoretical model in which firms undertake R&D in order to reduce future costs and thus improve future profits. Ulph noted that the current EC technology policy of encouraging the formation of research joint ventures (RJVs) seems to be motivated by an intention that Europe should regain its former world leadership in technology. From an analysis of the effects of this policy, Ulph concluded, however, that this is an inappropriate criterion for the design of technology policy, and that a policy of encouraging RJVs is not necessarily desirable once the possibility of market failure is taken into account. Further, where there are potential gains from the formation of RJVs, market forces will not necessarily produce the right amount of co-operation, and the losses from market failures may be substantial. This does not necessarily mean that a policy of promoting RJVs is bad, but rather that the expected gains cannot be taken for granted and will depend on the particular circumstances of specific joint ventures.
Various participants in the ensuing discussion noted that the reduction of future costs is only one motivation for R&D. Arye Hillman (Bar-Ilan University) suggested that a more important aspect of research was competitive product development, in which there is typically only one winner, or at most a small number. Other participants suggested that the information structure, the learning structure and the process by which information is traded had to be specified more fully in order for the appropriate policies to be identified. In reply, Ulph accepted all these points but noted that incorporating these developments would require a significantly more sophisticated model.
Another issue that will assume increased importance as the internal market nears completion is corporate taxation, since remaining differences in methods and rates of taxation across countries may affect firms' choice of location and thus cause distortions from the optimal allocation of resources. In a paper on `Corporation Tax and Foreign Direct Investment', Michael Keen (University of Essex) presented a framework for the evaluation of taxation policies and argued that corporation tax has no place as a means of extracting revenue from foreign nationals in an integrated Community. It should therefore be neutral to both the import and the export of capital (in order to ensure that investment decisions are not affected by considerations of differential tax rates or of double tax relief), even if autonomous national tax rates are to be retained.
Keen presented a large taxonomy of corporate taxation methods for both domestic and foreign firms and considered the conditions under which the two types of neutrality might be achieved. He concluded that full neutrality can best be achieved by giving parent multi-national corporations (MNCs) full credit for foreign tax payments underlying dividends received from affiliates, while taxing (or subsidizing) new equity injections into affiliates at the same rate.
A number of participants acknowledged that tax neutrality is desirable among EC members, while maintaining that the ability of member states to collect revenue from affiliates in non-member countries must be preserved. Ian Wooton (University of Western Ontario) suggested that the taxation model should also take into account MNCs based outside the Community. John Whalley noted that international tax treaties in general were in disorder and argued for a counterpart to GATT to monitor developments in this field. Riccardo Faini asked whether transfer pricing might enable MNCs to avoid domestic taxation and how this might affect the results. In reply, Keen agreed that it was desirable to take account of external MNCs, but maintained that transfer pricing did not play a significant role since in effect it is intra-company borrowing.
Stefano Micossi (Confindustria) and Gianfranco Viesti (Università Bocconi, Milano) presented a paper on `Japanese Investment in Manufacturing in Europe', in which they considered the disquiet aroused in some EC countries by the high level of Japanese FDI (foreign direct investment), which is often perceived as a means of circumventing EC-Japanese voluntary trade agreements.
Their analysis of the consequences of this investment and the various policy options available to the member states showed that the expected gains to the Community from such investment are likely to be concentrated in the localities in which it occurs, to the disadvantage of other countries. They also found that Japanese FDI in European manufacturing is still relatively small at present, and confined to scale-intensive, mass-production, assembly industries and electronics, but that it is growing rapidly in both scope and magnitude. They concluded that an EC- wide policy on FDI should be a priority not just after 1992 but also in the run-up to it.
Hideki Yamawaki (Wissenschaftszentrum Berlin für Sozialforschung) and John Whalley both noted that a substantial element of Japanese FDI in EC countries was directed towards the establishment of dealer networks and the provision of customer services. Such investment complements trade and should not be regarded as barrier jumping.

The papers presented at this conference will be published in early 1991 in a volume edited by L Alan Winters and Anthony Venables.