European Integration
Regional Issues

At a lunchtime meeting organized by CEPR and the London office of the Commission of the European Communities on 9 July, Paul Krugman presented the preliminary results of his recent research on the theme of `Centre and Periphery: Regional Issues in the New Europe'. Krugman is Professor of Economics at the Massachusetts Institute of Technology and a Research Fellow in CEPR's programme in International Trade. The meeting was held to mark the publication of Unity with Diversity in the European Economy: the Community's Southern Frontier, published by Cambridge University Press for the Centre for Economic Policy Research (see box). Professor Krugman is the contributor of two chapters to the volume. Financial support for the meeting was provided by the Economic and Social Research Council. The opinions expressed by Professor Krugman were his own, and not those of the ESRC or CEPR, which takes no institutional policy positions.

Krugman argued that the Europe of clearly identifiable national economic units will be replaced by a collection of regions. The conventional economic analysis of international trade will therefore be less useful in explaining the pattern of economic activity in Europe, in which trade and industry will be progressively dominated by competition among the regions to attract capital and labour from an increasingly integrated European resource pool.

Krugman noted that the European economy will increasingly come to resemble that of the United States, and he drew on both recent theoretical work and analogies with the US experience to focus on both the gains from European integration and the potentially serious problems this may entail.

The US industrialization was characterized by a strong tendency for industry to concentrate in regions in which it had enjoyed an early start. Each new industry located in the existing industrial core, where there were both a large concentration of demand and an established network of suppliers. Thus as late as 1960 the bulk of US manufacturing and nearly half the population remained in the same narrow `manufacturing belt' in which industrial production had been concentrated in 1870. Moreover, despite the dispersal of manufacturing industries since then, in recent years other sectors such as financial services have tended to repeat this pattern of concentration in established centres.

Krugman noted that to date the `centre-periphery' pattern in Europe has been much less pronounced. He attributed this to the existence of barriers to trade and to the relative immobility of capital and labour, which have dampened the tendency towards concentration that led to the dominance of the economic core in the US. It is widely assumed that the reduction of such barriers in Europe will benefit the poorer peripheral regions as industry relocates to take advantage of the lower wages in these regions.

Krugman maintained, however, that this effect may be outweighed by firms' need for access to both markets and suppliers. If this is indeed the case, as both his recent theoretical work and the US historical experience suggest, then both capital and labour will be pulled towards the centre. The Southern economies will not be able to compete with the North, and a shrinkage of their manufacturing sectors and a relative reduction in their manufacturing wages will result.

The simple extrapolation of the US experience may, however, be misleading when applied to the Community, since the natural barriers to trade between regions may be different in the two cases. Moreover, the new entrants to the Community may be able to ease their adjustment by the deliberate adoption of undervalued exchange rates in order to offset the concentration effect by a larger advantage in costs.

According to Krugman, the US experience also suggests that individual industries may come to be increasingly localized in the aftermath of European integration. Employment in many sectors of US industry is highly concentrated in small geographical areas. As a result, the major regions of the US, whose populations are comparable with those of the major EC member states, have strikingly different industrial structures. In contrast, the industrial structures of the major European nations are relatively similar, as a result of the barriers to trade and factor immobility that have characterized their evolution to date.

This may now be expected to change, as each individual industry tends to concentrate in one or two locations, and the industrial structures of the member states will correspondingly diverge. Although this may be expected to lead to significant efficiency gains in the longer term, it will also pose serious problems of adjustment and dislocation in the interim.

Krugman concluded that the practice of treating nation states as the relevant units for economic analysis is now obsolescent as far as the Community as concerned, because it assumes away the forces that generate centralization and localization. A regional perspective is now essential to the understanding of the economic prospects of the new Europe.