Detailed modelling of particular sectors and simulation of the effects of economic policy form an important element of CEPR's project on `The Consequences of 1992 for International Trade'. Issues emanating from this research were discussed at the project's third workshop in Kiel on 31 May/1 June, organized by L Alan Winters, Co-Director of the Centre's International Trade programme. This project is funded by the Commission of the European Communities under its SPES programme, and financial support is also provided by the UK Department of Trade and Industry and Foreign and Commonwealth Office.

Gernot Klepper (Institut für Weltwirtschaft, Kiel, and CEPR) opened the workshop by presenting preliminary work on the effects of post-1992 liberalization on the European pharmaceuticals market probably the most segmented and regulated industry in Europe. This segmentation is reflected by large price disparities across markets and emanates not from tariff and quantitative barriers but rather from differing national regulations and demand patterns and price controls in certain markets. While there are no real barriers to intra-EC trade, constraints on arbitrage nevertheless sustain price discrimination between markets. In Klepper's model, a price- discriminating monopolist serves two markets; and there are also arbitrageurs who buy the monopolist's output in the low-price, controlled market and sell it in the high-price, unrestricted market.

Klepper found that removing price controls in one market has ambiguous effects on overall prices and profits: the direction of change in the unrestricted market will depend on the costs arbitrageurs face. If their costs (e.g. repackaging and distribution) increase rapidly with activity as casual evidence suggests then removing price controls in one market may reduce prices in the other, because the volume of activity affects both the position and slope of the monopolist's residual demand curve in the unrestricted market. If arbitrageurs' supply function is very convex, a narrowing of price differentials induces a large decline in their activity. Hence, although the residual demand curve faced by the monopolist shifts outward, its slope declines sufficiently for the profit- maximizing price to fall. In conclusion, Klepper noted that the welfare effects of decontrolling prices are not straightforward, but he conjectured that pharmaceutical companies' increased profits are unlikely to outweigh consumer losses in the regulated market and possible losses in the unrestricted market.

Cillian Ryan (University College of Wales, Bangor) noted that the welfare measures took no account of the resource effect of increased arbitrage activity. Lars-Hendrik Röller (Institut Européen d'Administration des Affaires, Fontainebleau) suggested extending the model to allow for strategic interactions between firms.

Larry Karp (University of Southampton and CEPR) presented a joint paper with Jeffrey Perloff, `Helping by Hurting: Industrial Policy as an Alternative to Trade Policy', which compared the effects on oligopolistic industries of non-linear adjustment policies (e.g. adjustment subsidies to declining industries) and linear trade policies (e.g. export subsidies or taxes). In a duopoly model with a homogeneous good and quantity as the strategic variable, firms face convex adjustment costs so that the average cost of adjustment increases with the change in output. If the government can induce such a domestic firm to increase its output, it will be expensive for the firm to contract subsequently, so rival firms will reduce their sales and profits will shift to the domestic economy. Karp showed that a non-linear adjustment policy, which operates on the marginal unit, often achieves this aim at lower cost than a linear trade policy, which affects all units sold.

In a static framework, Karp found that an adjustment tax is the appropriate policy for a declining industry, since it provides the domestic firm with a credible commitment against further shrinkage by increasing the costs of adjustment; for an infant industry, on the other hand, a subsidy is optimal since it encourages the firm to expand. In a dynamic framework, the choice of policy depends upon the industry's initial conditions, but in general an adjustment tax is optimal. Karp also suggested that governments should consider such policies' strategic effects, e.g. when adjustment subsidies to a declining industry reduce the domestic firm's market power.

Richard Baldwin (Columbia University and CEPR) noted that incorporating entry by new firms might affect the model's results, and he suggested an extension to allow for differences in firms' costs and competitiveness, which in a dynamic framework would allow an examination of the policy's effects on the path of an industry's decline. Bernard Hoekman (GATT) emphasized that producer subsidy equivalents may be misleading indicators of the effects of domestic assistance, since taxing a domestic industry can harm foreign rivals.

In a paper on `The EC Footwear Market: Integration and Trade Policy', L Alan Winters (University of Birmingham and CEPR) modelled footwear trade and production for the Community with nine supplying countries, four EC markets and three broad types of footwear. He differentiated across all possible combinations of suppliers, markets and types, on the grounds of the large observed dispersion of prices across markets and suppliers of apparently similar footwear. Product differentiation by market implies that observed intra-EC price differentials are not wholly due to trade barriers, as has been commonly assumed, and the relative contributions of trade barriers and product differentiation cannot be determined a priori.

Winters proposed in future research to examine integration viewed as the harmonization of tastes across the Community by operating on supply parameters. If differentiation is due to design and sales effort, changes in tastes might not affect the relationship between the quantity of footwear consumed and consumer utility, but the costs of production for different Community markets should converge.
Winters also presented two sets of preliminary results on the Community's external trade. First, removing the current quantitative restrictions on imports from Eastern Europe will boost EC welfare by around 1.5-2% of total expenditure on footwear; and increased East European penetration of EC footwear markets should reduce imports from developing countries by 3-4% and EC production by 1-2%.

Second, the national quotas and VERs imposed on imports from Taiwan and Korea into France and Italy in 1988 reduced welfare relative to 1987 by only 0.3% of expenditure for France (where they replaced existing major barriers against Taiwan) but by 1.7% for Italy. Total losses relative to free trade were equal to 1.8% of the two countries' expenditure on footwear. The EC-wide quantitative restriction on all footwear imports from Taiwan and Korea, which replaced these measures in 1990, increased these costs to approximately 0.75% of total EC footwear expenditure and shifted much of the burden of protection to the previously more liberal economies, e.g. Germany and the UK.

Lars-Hendrik Röller suggested investigating the robustness of the results to changes in the model's parameters and experimenting with alternative aggregations of the data. John Marshall (UK Department of Trade and Industry) noted that many `grey areas' remain in European countries' trade policies with Korea and Taiwan, which may include informal national restrictions on footwear.
Jan Haaland (Norwegian School of Economics and Business Administration, Bergen) presented the final paper of the workshop, written with Ian Wooton, on `Market Integration, Competition and Welfare'. They developed a simple model of international trade in an oligopolistic industry to isolate the effects of integration on competitive pressures. Haaland applied this model, which allows for differences in tastes between consumers in the two markets and specifically for consumers' possible `home market bias', to the case of a differentiated product traded between two symmetric countries. He compared equilibria under segmented and integrated markets.

In conventional models, integration reduces firms' initial domestic market power over time because their post-integration market power is determined by their shares of the overall enlarged market. Haaland found that the opposite effect is possible, however, since the initial segmented markets allow `dumping', which may have pro-competitive effects. If trade costs or national preference biases remain, an integrated market with differentiated products may have a less competitive equilibrium than a segmented market with the same number of firms. This occurs when firms that are no longer able to dump because of integration find it more expensive to serve foreign markets, and competitive pressures from foreign firms are therefore reduced. Haaland concluded that the conventional wisdom that market integration leads to a lower home-market price, gains for consumers and losses for producers need not hold. Indeed, integration may cause all prices to rise; and even in the more `normal' case where the home-market price falls, import prices will rise and the welfare consequences are unclear.

Joaquim Oliveira-Martins (Centre d'Etudes Prospectives d'Informations Internationales, Paris, and OECD) suggested using Haaland's model to examine the harmonization of tastes as mentioned by Winters. Also, more sophisticated modelling of production could allow for the increased homogeneity of supply conditions that may follow from integration.