Regardless of the eventual fate of the Maastricht Treaty and the enforcement of the single market, enlargement is set to dominate the European Community's policy agenda in the coming years. Four EFTA countries have submitted formal applications and are serious candidates for membership by the mid-1990s, while regionalism is one of the most important and also least understood issues facing economists and policy-makers today. A CEPR conference with the Yrjö Jahnsson Foundation at Sannäs, Borgå, Finland, on `The European Community's New Entrants: Shifting Weights in Europe' on 13/15 May, addressed the implications of EC enlargement for current and prospective member states. The conference was organized by Richard Baldwin, Professor of International Economics at the Graduate Institute of International Studies, Geneva, and Co-Director of CEPR's International Trade programme, and Jaakko Kiander, Scientific Director at the Yrjö Jahnsson Foundation. Papers presented focused on Community-wide issues such as shifting weights in decision-making, structural fund expenditure and common migration, industrial and competitiveness policies; sector-specific issues such as the Common Agricultural Policy and shifts in production and exports of capital within manufacturing; and the political economy of regionalism and its relationship with global liberalization.

In `An Assessment of the Economic Consequences of EC Enlargement: The Case of Finland', Kari Alho (Research Institute of the Finnish Economy (ETLA)) discussed the possible consequences of EC membership for the current EFTA countries, especially Finland. He noted the findings of a recent ETLA study which found potential for a welfare gain to Finland, since EC membership involves a reduction in current high levels of support to agriculture, the restructuring of other protected sectors and participation in EMU. The degree to which this potential is utilized will depend, however, on Finland's willingness and capacity to undertake an adjustment process and shift the existing `national rent-sharing equilibrium' towards a more competitive one. EC membership will also enable the EFTA countries to overcome the `influence deficit' they currently face within the European Economic Area (EEA).

Yngve Lindh (Sveriges Riksbank) maintained that EMU will also impose costs on new EC entrants and that these may be greater for Finland than for Sweden. Andreas Wörgötter (Institut für Höhere Studien, Wien, and CEPR) called for empirical evidence of potentially high efficiency gains in agriculture and from exploiting scale economies; such estimates for Austria indicate that the efficiency loss of current domestic policies is much lower than Alho suggested for Finland.

In `Variance Decomposition of Growth Fluctuations in Small European Countries', Andreas Wörgötter identified and estimated the local and global shocks that drove the growth of real GDP fluctuations for seven countries (Austria, Denmark, Finland, the Netherlands, Norway, Sweden and Switzerland) during 1973-92. His results confirmed the well-known differences between the Nordic countries and the others: growth fluctuations of the Nordic entrants basically reflected local shocks, while some 40-70% of such fluctuations in the other small countries reflected current and past global shocks. This divergence may relate to the two country groups' different exchange rate regimes. These results suggest that enlargement to include the Nordic entrants may prove difficult, for which Denmark may be a leading indicator, while Austria seems to be sufficiently integrated with the EC economy already to look forward to membership with greater confidence.

Pekka Ahtiala (University of Tampere) stressed that the oil shocks of the 1970s made estimation over this period difficult. Carl Hamilton (Institute for International Economic Studies, Stockholm, and CEPR) attributed the local shocks to exchange rate disturbances: the Nordic countries tended to follow the UK business cycle and German interest rates. Thorvaldur Gylfason (University of Iceland and CEPR) suggested that the EFTA members' good record of growth may be founded on the accumulation of debt and should be viewed in the context of changes in stocks and assets.

In `Trade Effects of Regional Aid', written with Carol Ann Rogers, Philippe Martin (Institut Universitaire de Hautes Etudes Internationales, Genève) developed a model in which trade is motivated by increasing returns to show that these are associated with location in countries with better infrastructure. Regional trade integration may therefore induce capital flight from poor to rich countries. EC regional aid policies to finance investment in public infrastructure (specifically in transport, telecommunications, energy and education) in the poorest regions may reduce such disparities and thereby offset this effect. Such policies may be interpreted as a price the richer countries pay for the benefits of full integration of trade and liberalization of capital flows. Martin reported that empirical work showed that differences in levels of public infrastructure account for European patterns of intra-industry trade, location and per capita GDP as the model predicted. Telecommunications and educational infrastructures appeared the most important determinants of industry location and per capita GDP, while transport infrastructure had no such effects.
Harry Flam (Institute for International Economic Studies, Stockholm, and CEPR) noted that convergence and catch-up have led to substantial equalization of national income levels within Europe. Martin agreed but noted that this convergence between member states masked continued divergence among regions. Heather Hazard (Copenhagen Business School) pointed out that governments are now eager to attract foreign direct investment by improving their infrastructures. Andreas Wörgötter suggested that the transfers required by the Community's structural funds may be viewed as the price the North has to pay to discourage migration from the South.

In `Regional Effects of European Integration: A Progress Report on the Effects of Product Market Integration and Capital Movements', joint with Victor Norman, Jan Haaland (Norwegian School of Economics and Business Administration, Bergen, and CEPR) developed a computable general equilibrium (CGE) model with imperfectly competitive product markets to study the effects of increased capital and product market integration on the location of industrial production in Europe. They found no marked tendency for product market integration to enhance either industrial concentration in EC North or interregional specialization and trade. Industrial production should increase substantially in EC South instead, at the expense of the EFTA countries, although skill-intensive production in the latter will also rise. Quite modest initial differences in rates of return may induce substantial capital flows from EFTA to EC South, and product market integration will do nothing to offset this. These results provide no support for the widespread view that EC membership will enable EFTA countries to avert the danger of capital flight. Extending the model to incorporate scale economies might yield concentration effects as found in the `new' trade-and-geography literature, however, while allowing capital flows to incur trade costs may reduce the incentives to move production rather than final goods in an integrated market.

Carl Hamilton questioned the relevance of Haaland and Norman's approach, since CGE models often produce large changes as a result of small price differentials. He also questioned their inclusion of Italy as a rich country in `EC South'. Stephen Yeo (CEPR) asked whether including Eastern Europe would affect their results. Pentti Vartia (Research Institute of the Finnish Economy) stressed that levels of capital stock reallocation had been high during the 1980s, when investment abroad was the only means by which large EFTA firms could expand.

In `Industrial and Competitiveness Policies in the EFTA Countries: Past Patterns and Future Prospects in an Enlarged Europe', Heather Hazard contrasted the EFTA countries' recent industrial and competition policies with the various initiatives taken at national and EC levels within the Community. She evaluated their contributions to improving the functioning of market mechanisms in terms of efficiency- and equity-seeking criteria. With the notable exception of the agricultural sector, the EFTA countries were philosophically liberal, and they have successfully used the pressures generated by negotiations with the Community over the EEA and prospective membership to negotiate with domestic opponents of liberalization. Their accession to full membership is likely to reinforce the pressures to reduce market-distorting industrial policies within the Community while maintaining social welfare objectives.

Jaakko Kiander agreed that the EFTA countries' trade policies have been largely liberal, but he emphasized the importance of exchange rate policies in maintaining the Nordic countries' competitiveness. Jan Haaland questioned Hazard's assumption that the EFTA countries will pursue more liberal policies; Norwegian opposition to EC accession derives largely from opposition to trade liberalization, and it is doubtful whether it could really pursue more liberal policies outside the Community.

In `A Domino Theory of Regionalism', Richard Baldwin contrasted the rapid growth of regional liberalization across the world with the glacial pace of the multilateral GATT talks. Baldwin dismissed the `GATT-is-dead' school of thought which views multilateral negotiations as outmoded and too cumbersome to deal with the complexities of modern trade issues. He proposed a simple model in which deeper integration of an existing regional bloc triggers membership applications from countries that were previously content to be non-members. The stance of a national government over membership reflects the domestic political equilibrium between pro- and anti-membership forces. Firms in non-member countries that export to the bloc favour membership; its closer integration damages their profits and stimulates them to engage in greater political activity, which can tilt the balance so that a previously indifferent government will join. Enlargement further increases the costs to non-members, which increases lobbying for membership until a new political equilibrium is attained with a larger regional bloc.

Thorvaldur Gylfason suggested extending Baldwin's model to consider the current EC members' willingness to allow non-members to join and argued that a dynamic model of the Community's deepening need not lead to the widening described in Baldwin's static model. Philippe Martin argued that small countries that remain outside the Community can free ride; Pentti Vartia agreed but stressed that the EFTA countries are unlikely to try becoming the `Hong Kongs of Europe' for reasons of foreign policy.
In `Federal Fiscal Constitutions. Part 1: Risk Sharing and Moral Hazard', written with Torsten Persson, Guido Tabellini (Università di Brescia, Innocenzo Gasparini Institute for Economic Research, Milan, and CEPR) studied equilibrium fiscal policy under alternative constitutional arrangements for a `federation' of countries of the type that may emerge from current developments in Europe. In the model, `local' policy redistributes across individuals and affects the probability of aggregate shocks while `federal' policy shares international risk. Policies are chosen under majority rule, and there is moral hazard since federal risk-sharing can induce local governments to enact policies that increase local risk. Tabellini contrasted the `horizontally-ordered' federal system in the US (where the federal government would deal directly with individuals) with the `vertically-ordered' system in the EC (whose federal government would deal with member states). He showed that these alternative arrangements create different incentives for policy-makers and voters, which give rise to different political equilibria. Centralization of functions and power may be welfare improving under appropriate institutions, but this only applies to the moral-hazard problem for a federation whose member countries are reasonably similar.

Pertti Haaparanta (Helsinki School of Economics and Business Administration) pointed out that the model was rather general and could be applied to different levels of government. Richard Baldwin suggested applying the model to trade policy.

In `Voting Power and Decision-Making Control in the Council of Ministers before and after the Enlargement of the EC', Mika Widgrén (Research Institute of the Finnish Economy) investigated the effects of EC expansion to include Austria, Finland, Norway and Sweden. The new entrants will get 15% of the votes within the Council of Ministers, which is remarkably high relative to their share of the EC(16) population, although current members' relative loss of power is smaller than in the Community's previous enlargements. Widgrén found that reaching decisions will become increasingly difficult as the Community expands; current members will not lose control, but new members will wield remarkable power to block decisions. A high level of national control enhances the powers of officials in preparatory bodies, so European integration has the best chance of success in cases where there is greater homogeneity among member states or where this may be bought with side-payments. The proposed switch from qualified to simple majority voting reduces member states' negative control over decisions substantially, but it will barely change the balance of power between North and South and is therefore unlikely to lead to any major policy changes.

Andreas Wörgötter suggested analysing other enlargements and different coalitions and asked for empirical evidence to support these theoretical results. Carl Hamilton pointed out that national interests may vary over time after enlargement.

In `Implications of EC Expansion for European Agricultural Policies, Trade and Welfare', joint with Rod Tyers, Kym Anderson (University of Adelaide and CEPR) argued that EC expansion to include the EFTA countries and increased provision of preferential access to farmers in the transforming economies of Eastern Europe would have opposite effects on Europe's food surplus and world food prices if EC domestic prices remain unchanged. Their combined impacts on net economic welfare in Europe and elsewhere may therefore be positive or negative. Anderson reported simulations on a multi-commodity model of world food markets up to the year 2000. Granting free access to EC food markets even to the four most advanced Central European countries would increase European agricultural protection and almost wipe out the global benefit from reducing EFTA members' food prices to those of the EC(12). The budgetary cost to the Community of allowing such access would amount to one-quarter of its expenditure on farm price support, which is far more than would accrue from the EFTA countries' accession.

Hannu Törmä (University of Jyväskylä) suggested adopting a general equilibrium approach, disaggregating the EFTA countries to consider a wider variety of enlargement scenarios, and extending the model to include membership fees.

Presenting `Services and Economic Integration', written with Tiina Heikkinen, Pertti Haaparanta described a stylized model in which most services are produced to satisfy the needs of immobile customers. He used this model, which incorporates oligopolistic competition and product differentiation and is therefore suitable for analysing retail trade or retail banking, to examine the effects of economic integration on the price and variety of services. He found that the Nordic EFTA countries' explicit concerns that integration will worsen their regional problems may be valid in some cases, but the overall picture is quite positive; foreign firms' mode of entry also significantly determines the effects of integration. Finally, he considered whether integration will increase the concentration of economic activity and hence `worsen' regional problems, as many of its opponents claim. He reported that there are forces tending to increase such concentration, but further work is needed to evaluate its impact on welfare.

Bernard Hoekman (GATT Secretariat, Geneva, and CEPR) welcomed the contribution to the literature since consumer services had not been modelled before, but this paper focused on retail trade and intermediate inputs rather than services.
In `Migration in the Expanded EC', Riccardo Faini (Università di Brescia and CEPR) reviewed Community policy and intergovernmental agreements among EC member states on migration and considered their implications for labour markets. He found that even the full abolition of intra-EC border controls is unlikely to induce a substantial increase in the migratory flows of EC citizens. In particular, the propensity to migrate from the poorer countries of the EC South is now much weaker than in the 1950s and 1960s. Migration flows of non-EC citizens may increase, however, since they typically have poorer information than natives about local labour markets and weaker cultural and linguistic links with their place of residence. Such a stock of relatively mobile workers may benefit the Community by enhancing its regions' ability to adjust to idiosyncratic shocks. The continued presence of widely different regulations across the EC and EFTA member countries may provide potential migrants with perverse incentives to relocate, however, which highlights the need for EC countries to harmonize their policies on the admission and employment of non-EC citizens.

Pentti Vartia welcomed Faini's description of the institutions of common labour markets but suggested taking greater account of expected migration from Eastern Europe. He also suggested including distance between countries as an explanatory variable in migration equations. Guido Tabellini noted that changes to the age composition of the population may affect migration flows.

In `Customs Unions, Regional Trading Blocs and Welfare', Håkan Nordström (Institute for International Economic Studies, Stockholm) developed a multi-country regional variant of the Krugman model of intra-industry trade. He investigated whether the regional integration of trading blocs will spur trade reform and promote multilateral free trade or lead to the development of exclusionary, trade-diverting entities that will reduce world welfare. He found that widespread concerns that inward-looking blocs will curtail market access to non-members will induce countries that were previously happy to remain non-members to seek closer alliances with their major trading partners. Whether a local bloc will accept all prospective candidates as members seems to depend primarily on the region's size: small blocs will favour expansion to improve their chances of negotiating free trade agreements with other blocs. Their expansion may be necessary to enhance the current larger blocs' incentives to reach such agreements and thus prove essential to the development of multilateralism in the longer run.

Seppo Honkapohja (Academy of Finland, University of Helsinki and CEPR) noted that the model seemed rather rich and asked what consequences asymmetric blocs in different regions would have on Nordström's results. Pertti Haaparanta noted that the European Community is the only successful customs union and asked if this may have impeded their formation elsewhere.


'Towards an Integrated Europe' edited by Richard Baldwin
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