Theorie und Politik der Europäischen Integration Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects Trade and Competition Policies Prof. Dr. Herbert Brücker

Last Lecture Preferential Trade Liberalisation The PTA Diagram Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Last Lecture Preferential Trade Liberalisation The PTA Diagram Free Trade Equilibrium MFN Tariff Equilbrium Unilateral Trade Discrimination Supply Switches Welfare Effects Empiry: Is Trade Diversion an Issue? Welfare Effects of a Customs Union Customs Union vs. Free Trade Area WTO Rules and Customs Union/Free Trade Areas Art. 24 WTO

Home RoW Partner XSR XSP P’ P MD Uniform MFN Tariff XR’ XR XP’ XP M’ Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation Uniform MFN Tariff MSMFN Border price Border price Domestic price Home RoW Partner XSR XSP MS P’ T P P’-T Pa T p* MD XR’ XR RoW Exports Partner Exports Home imports XP’ XP M’ MFREE

Discriminatory, Unilateral Liberalization Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation Discriminatory, Unilateral Liberalization MSMFN Border price Border price Domestic price Home RoW Partner MSPTA XSR XSP MS P’ P” P” T P’-T P”-T Pa T 1 p* MD RoW Exports Partner Exports Home imports XR” XR’ XP’ XP” M’ M”

Domestic Price and Border Price Changes Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation Domestic Price and Border Price Changes Border price Border price Domestic price MSMFN XSR XSP MSPTA MS P’ P” P” T P’-T P’-T P”-T MD XR” XR’ RoW Exports XP’ XP” Partner Exports M’ M” Home imports

Domestic Price and Border Price Changes Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation Domestic Price and Border Price Changes Border price Border price Domestic price MSMFN XSR XSP MSPTA MS P’ P” P” T P’-T P’-T P”-T domestic price falls to P’’ from P’ MD XR” XR’ RoW Exports XP’ XP” Partner Exports M’ M” Home imports

Domestic Price and Border Price Changes Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation Domestic Price and Border Price Changes Border price Border price Domestic price MSMFN XSR XSP MSPTA MS P’ P” P” T P’-T P’-T P”-T domestic price falls to P’ from P” Partner-based firms see border price rise, from P’-T to P” MD XR” XR’ RoW Exports XP’ XP” Partner Exports M’ M” Home imports

Domestic Price and Border Price Changes Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation Domestic Price and Border Price Changes Border price RoW firms see border price fall from P’-T to P”-T. Border price Domestic price MSMFN XSR XSP MSPTA MS P’ P” P” T P’-T P’-T P”-T domestic price falls to P’ from P” Partner-based firms see border price rise, P’-T to P” MD XR” XR’ RoW Exports XP’ XP” Partner Exports M’ M” Home imports

Quantity Changes: Supply Switching Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation Quantity Changes: Supply Switching Domestic price Home imports MD RoW Exports Partner XSP XSR MS MSMFN M’ Border price MSPTA P’ T P” P’-T P”-T XR” XR’ XP’ XP” M”

Quantity Changes: Supply Switching Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisatio Quantity Changes: Supply Switching Domestic price Home imports MD RoW Exports Partner XSP XSR MS MSMFN M’ Border price MSPTA P’ T P” P’-T P”-T XR” XR’ XP’ XP” M” RoW exports fall

Today's Lecture - Overview Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Today's Lecture - Overview Market Size and Scale Effects EU Competition Policies EU Trade Policies

Today's Reading Market Size and Scale Effects Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Today's Reading Market Size and Scale Effects Baldwin & Wyplosz (2009) “The Economics of European Integration”, McGraw-Hill, Ch 6. Competition and State Aid Policies Baldwin & Wyplosz (2009) “The Economics of European Integration”, McGraw-Hill, Ch 14. Trade Policies Baldwin & Wyplosz (2009) “The Economics of European Integration”, McGraw-Hill, Ch 15.

Facts: integration associated with mergers, acquisitions, etc. Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Market Size Matters European leaders always viewed integration as compensating small size of European nations. Implicit assumption: market size good for economic performance. Facts: integration associated with mergers, acquisitions, etc. In Europe and more generally, ‘globalisation.’

Sketch of economic logic Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Sketch of economic logic liberalisation  de-fragmentation  pro-competitive effect  industrial restructuring (M&A, etc.) RESULT: fewer, bigger, more efficient firms facing more effective competition from each other.

Sketch of economic logic Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Sketch of economic logic liberalisation  de-fragmentation  pro-competitive effect  industrial restructuring (M&A, etc.) RESULT: fewer, bigger, more efficient firms facing more effective competition from each other.

Monopolies and duopolies Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Monopolies and duopolies Firms are not price takes Elasticity of demand curve constrains price levels Profit maximum is achieved if prices are chosen in a way that marginal revenues equal marginal costs Duopoly: Price and production depends on expectations on behaviour of competitors Cournot-Nash equilibrium: Optimum is achieved when symmetric firms produce same level of output

Economic logic (background): Monopoly case Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Economic logic (background): Monopoly case Demand Curve Price Price Marginal Revenue Curve Marginal Cost Curve P* Demand Curve P’ A P” B D Marginal Cost C E Q’ Q’+1 Q* Sales Sales

Economic logic (background): Monopoly case Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Economic logic (background): Monopoly case Demand Curve Price Price Marginal Revenue Curve Demand Curve P’ Marginal Cost Curve P* A P” Extra revenues of one unit: D + E – A. „marginal revenue“ B D Marginal Cost C E Q’ Q’+1 Q* Sales Sales

Economic logic (background): Monopoly case Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Economic logic (background): Monopoly case Demand Curve Price Price Marginal Revenue Curve Demand Curve P’ Marginal Cost Curve P* A Profitmaximum: marginal revenue equals marginal costs. P” B D Marginal Cost C E Q’ Q’+1 Q* Sales Sales

Duopoly case, example of non-equilbrium Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Duopoly case, example of non-equilbrium price price Firm 1’s expectation of sales by firm 2, Q2 Firm 2’s expectation of sales by firm 1, Q1 p1’ Demand Curve (D) Demand Curve (D) p2’ Residual Demand Curve firm 1 (RD1) Residual Demand Curve firm 2 (RD2) A1 MC A2 MC x1’ Firm 1 sales x2’ Firm 2 sales Residual Marginal Revenue Curve firm 1 (RMR1) Residual Marginal Revenue Curve firm 2 (RMR2)

Duopoly and oligopoly case, equilbrium outcome Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Duopoly and oligopoly case, equilbrium outcome price Typical firm’s expectation of the other firm’s sales price Typical firm’s expectation of other the other firms’ sales p* D D p** RD RD’ A MC A MC RMR RMR’ sales x* 2x* x** sales 3x** Duopoly Oligopoly

Presentation of theory here in Breakeven-Competition (BE-COMP)-Diagram Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Bringing this to trade Brander and Krugman (1983) Building on Nash they combine increasing returns to scale, imperfect competition and trade Presentation of theory here in Breakeven-Competition (BE-COMP)-Diagram

Breakeven-Competion (BE-COMP) Diagram Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Breakeven-Competion (BE-COMP) Diagram Mark-up (m) COMP curve BE (break-even) curve m’ n’ mmono mduo n=1 n=2 Number of firms

Breakeven-Competion (BE-COMP) Diagram Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Breakeven-Competion (BE-COMP) Diagram Mark-up (m) COMP curve BE (break-even) curve m’ n’ mmono mduo n=1 n=2 Number of firms Markup (µ): Price markup over costs, depends on competition

Breakeven-Competion (BE-COMP) Diagram Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Breakeven-Competion (BE-COMP) Diagram Mark-up (m) COMP curve BE (break-even) curve m’ n’ mmono mduo n=1 n=2 Number of firms Breakeven (BE) curve: With increasing returns to scale only a limited number of firms can survive. Survival depends on markup µ.

Details of COMP curve p' mmono p" mduo D R-D (duopoly) Marginal cost Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Details of COMP curve price p' mmono A’ p" mduo B’ D Monopoly mark-up Duopoly mark-up COMP curve R-D (duopoly) Marginal cost curve MC B A n=1 n=2 R-MR MR (monopoly) Typical firm’s sales xduo xmono

Details of BE curve: closed economy Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Details of BE curve: closed economy Mark-up (i.e., p-MC) euros price Home market po=mo+MC Demand curve BE A ACo=po B A po mo B COMP AC MC n” no n’ Sales per firm Co Total sales x”= Co/n” x’= Co/n’ xo= Co/no

Outline of BE-COMP Diagram Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Outline of BE-COMP Diagram euros price Mark-up Home market COMP curve Average cost curve Demand curve Demand curve BE E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n” 2n’ x’ x” Sales per firm C’ C” Total sales

Outline of BE-COMP Diagram Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Outline of BE-COMP Diagram euros price Mark-up Home market COMP curve Average cost curve Demand curve Demand curve BE Average cost of representative firm equals price after adjustment of firm number E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n” 2n’ x’ x” Sales per firm C’ C” Total sales

Outline of BE-COMP Diagram Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Outline of BE-COMP Diagram euros price Mark-up Home market COMP curve Average cost curve Demand curve Demand curve BE Competition curve shows combination of mark-up and equilibrium firm number Average cost of representative firm equals price after adjustment of firm number E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC MC n’ n” 2n’ x’ x” Sales per firm C’ C” Total sales

Outline of BE-COMP Diagram Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Outline of BE-COMP Diagram euros price Mark-up Home market COMP curve Average cost curve Demand curve Demand curve Breakeven curve is upward sloping, since sales per firm fall with increasing firm number such that higher mark-up is needed to breakeven BE Average cost of representative firm equals price after adjustment of firm number E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC MC n’ n” 2n’ x’ x” Sales per firm C’ C” Total sales

Addressing European integration Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Addressing European integration Assume that trade-to-non trade liberalization provides (i) each firm with a market of twice its side and (ii) double the number of firms in each market What happens to markup, equilibrium number of firms, average costs, price and demand?

No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies No-trade-to-free-trade integration euros price Mark-up Home market After integration, each firm has (i) second market of same size and (ii) twice the number of competitors Average cost curve Demand curve BE E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC MC n’ n” 2n’ x’ x” Sales per firm C’ C” Total sales

No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies No-trade-to-free-trade integration euros price Mark-up Home market Average cost curve Demand curve BE Competition effect: number of firms is 2n’, such that mark-up declines to A at given firm number. E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC MC n’ n” 2n’ x’ x” Sales per firm C’ C” Total sales

No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies No-trade-to-free-trade integration euros price Mark-up Home market Market size effect: BE curve shifts to outward to the right. At given number of firms (point 1) we have no equilibrium). Average cost curve Demand curve BE E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC MC n’ n” 2n’ x’ x” Sales per firm C’ C” Total sales

No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies No-trade-to-free-trade integration euros price Mark-up Home market Smaller mark-up and higher competition reduces prices to pA. Below breakeven point for given number of firms. Industrial restructuring results in E’’ equilibrium number of firms. Average cost curve Demand curve BE E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC MC n’ n” 2n’ x’ x” Sales per firm C’ C” Total sales

No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies No-trade-to-free-trade integration euros price Mark-up Home market Since each firm has a larger market in new equilibrium, average costs decline. Efficiency gain. Average cost curve Demand curve BE E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC MC n’ n” 2n’ x’ x” Sales per firm C’ C” Total sales

No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies No-trade-to-free-trade integration euros price Mark-up Home market Average cost curve Demand curve BE Welfare gain: C. Consumer benefit from (i) lower prices, (ii) higher consumption. E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC MC n’ n” 2n’ x’ x” Sales per firm C’ C” Total sales

Pro-competitive effect: Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Economic logic Integration: no-trade-to-free-trade: BE curve shifts out (to point 1). (Larger market effect) Defragmentation: PRE typical firm has 100% sales at home, 0% abroad; POST: 50-50 , Can’t see in diagram. Pro-competitive effect: Equilibrium moves from E’ to A: Firms losing money (below BE). Pro-competitive effect = markup falls. short-run price impact p’ to pA.

Industrial Restructuring: Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Economic logic (cont.) Industrial Restructuring: A to E”, number of firms, 2n’ to n”. firms enlarge market shares and output, More efficient firms, AC falls from p’ to p”, mark-up rises, profitability is restored. Result: bigger, fewer, more efficient firms facing more effective competition. Welfare: gain is “C”.

M&A activity is high in EU. Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Facts M&A activity is high in EU. much M&A is mergers within one member state about 55% ‘domestic’; remaining 45% split between: one is non-EU firm (24%), one firm was located in another EU nation (15%), counterparty’s nationality was not identified (6%). Empirical evidence: Single Market Programme reduced Price-Cost Margins by 4 per cent on average. High variance: - 15 per cent in office equipment sector -0.1 per cent in brewing

Distribution of M&A quite varied: Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Facts Distribution of M&A quite varied: Big 4: share M&As much lower than share of the EU GDP. I, F, D 36% of the M&As, 59% GDP. Except UK. Small members have disproportionate high share of M&A. This picture fits pretty well into theoretical expectations: Small countries suffer more from fragmentation of markets such that pressure for industrial restructuring is higher compared to countries with a larger market share

Theory and Politics of European Integration Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Facts

Why M&A mostly within EU? Why UK’s share so large? Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Facts Why M&A mostly within EU? Why UK’s share so large? Non harmonised takeovers rules. some members have very restrictive takeover practices, makes M&As very difficult. others, UK, very liberal rules. Lack of harmonisation means restructuring effects very impact by member states.

EU Competition and State Aid Policy Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU Competition and State Aid Policy

Competition and subsidies Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Competition and subsidies Two immediate questions: “As the number of firms falls, isn’t there a tendency for the remaining firms to collude in order to keep prices high?” “Since industrial restructuring can be politically painful, isn’t there a danger that governments will try to keep money-losing firms in business via subsidies and other policies?” The answer to both questions is “Yes”. See Chapter 14, 3rd Edition.

Exclusive competency of EU; Commission controls. Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU Competition Policy Exclusive competency of EU; Commission controls. 2 aspects: mergers & anti-competitive behaviour. Economic integration yields less firms, higher concentration but more cross-border competition Creates incentives to collude and undertake anti-competitive measures Look at justification for putting competition policy at the EU level

Anti-competitive behaviour Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Anti-competitive behaviour Collusion is a real concern in Europe. dangers of collusion rise as the number of firms falls. Collusion in the BE-COMP diagram COMP curve is for ‘normal’, non-collusive competition Firms do not coordinate prices or sales Other extreme is ‘perfect collusion’ Firms coordinate prices and sales perfectly Max profit from market is monopoly price & sales Perfect collusion is where firms charge monopoly price and split the sales among themselves

Economic effects Consider two cases: Perfect collusion: Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Economic effects Consider two cases: Perfect collusion: Firms set prices to monopoly level and divide profits equally. Price increases. Markup increases. More firms enter market. Eventually, zero profit condition restored, i.e. price equals average costs. Mark-up BEFT mmono A B mB E” m” COMP n=1 n” nB 2n’ nP’ Number of firms

Prices higher, pB> p”, smaller firms, higher average cost. Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Economic effects Partial collusion Less opportunities to cheat 2n’ is too high for all firms to break even. Industrial consolidation proceeds as usual, but only to nB. Zero profits earned by all at point B. Prices higher, pB> p”, smaller firms, higher average cost. Mark-up BEFT mmono A B mB E” m” COMP n=1 n” nB 2n’ Number of firms

Economic effects (cont.) Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Economic effects (cont.) price The welfare cost of collusion (versus no collusion) four-sided area marked by pB, p”, E” and B. Demand curve Mark-up BEFT pmono mmono Perfect collusion A B B pB E” Partial collusion E” p” COMP n=1 n” nB Number of firms Total sales CB

Antitrust and cartels. The Commission tries: Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU Competition Policy To prevent anti-competitive behavior, EU policy focuses on two main axes: Antitrust and cartels. The Commission tries: to eliminate behaviours that restrict competition (e.g. price-fixing arrangements and cartels) to eliminate abusive behaviour by firms that have a dominant position Merger control. The Commission seeks: to block mergers that would create firms that would dominate the market.

Suppose price without cartel would be P. Cartel raises price to P’. Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Economics of cartels euros Quantity C’ C P’ P = AC a b Demand curve Suppose price without cartel would be P. Cartel raises price to P’. Consumers lose: -a-b; ‘ripoff’-effect Producers gain: a. Net loss: b. “technical inefficiency”

The vitamin cartels (Box 11‑1) Theory and Politics of European Integration Lecture 7 Trade and Competition Policies The vitamin cartels (Box 11‑1) In 2001, Commission fined 8 companies for their participation in cartels that eliminated competition in the vitamin sector (vitamins A, E, B1, B2, B5, B6, C, D3, Biotin, Folic acid, Beta Carotene and carotinoids) for more than ten years. The European vitamins market is worth almost 1 billion euros a year. The firms fixed prices, allocated sales quotas, agreed on and implemented price increases and issued price announcements in according to agreed procedures. EU can fine firms up to 10 % of total annual sales.

The vitamin cartels (Box 11‑1) (cont.) Theory and Politics of European Integration Lecture 7 Trade and Competition Policies The vitamin cartels (Box 11‑1) (cont.) They also set up a mechanism to monitor and enforce their agreements and participated in regular meetings to implement their plans. This included the establishment of formal structure and hierarchy of different levels of management, often with overlapping membership at the most senior levels to ensure the functioning of the cartels, the exchange of sales values, volumes of sales and pricing information on a quarterly or monthly basis at regular meetings, and the preparation, agreement and implementation and monitoring of an annual "budget" followed by the adjustment of actual sales achieved so as to comply with the quotas allocated. Hoffman-La Roche of Switzerland received the largest fine (462m euros) for being the cartel ringleader, which also included BASF and Merck (Germany), Aventis SA (France), Solvay Pharmaceuticals (the Netherlands), Daiichi Pharmaceutical, Esai and Takeda Chemical Industries (Japan).

Exclusive territories Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Exclusive territories euros Quantity PGermany PUK DGermany DUK MC MRGermany MRUK More common anti-competitive practice is ‘exclusive territories’ Nintendo example; high prices in Germany vs UK. Prevent arbitrage within the EU (illegal). European Commission fined Nintendo and the 7 distributors 168 million euros.

Exclusive territories Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Exclusive territories euros Quantity PGermany PUK DGermany DUK MC MRGermany MRUK German demand curve steeper, i.e. higher willingness to pay (lower price elasticity) UK has flatter demand curve (e.g. more opportunties to substitute, higher price elasticity) Profits are maximized where marginal revenue and marginal costs curve intersect This implies requesting higher price in DE relative to UK

Abuse of dominant position Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Abuse of dominant position Firms that are lucky or possess excellent products can establish very strong positions in their market. Not a problem, per se position may reflect superior products and/or efficiency e.g. Google’s triumph However dominance may tempt firm to extract extra profits from suppliers or customers Or arrange the market to shield itself from future competitors. E.g. hiding the programm code. Illegal under EU law ‘abuse of dominant position.’ e.g. Microsoft with media software charge high price of Word, etc. where the competition has been driven out of biz (WordPerfect, etc.), but give for free all software where there is still competition.

Williamson diagram Merger control Initially P=AC. Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Merger control euros Quantity C’ C P’ P=AC a b c Demand curve AC’ Williamson diagram Initially P=AC. Merger implies lower AC to AC’, but raises the price to P’. DCS=-a-b; ‘ripoff’ DPS=+a+c Net welfare = -b+c ; ambiguous, ‘efficiency defence’ Laissez-faire (in US and increasingly in EU); if free entry then eventually P driven down to AC’. Overall gains as in BE-COMP diagram.

Restructuring prevention. Unfair competition. Theory and Politics of European Integration Lecture 7 Trade and Competition Policies State aid economics Look at two cases: Restructuring prevention. Unfair competition.

Restructuring prevention Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Restructuring prevention Consider subsidies that prevent restructuring Specifically, each governments make annual payments to all firms exactly equal to their losses i.e. all 2n’ firms in Figure 6-9 analysis break even, but not new firms Economy stays at point A This changes who pays for the inefficiently small firms from consumers to taxpayers. Mark-up BE BEFT E’ 1 m' E” mA A COMP n’ n” 2n’ Number of firms

Restructuring prevention: size of benefit Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Restructuring prevention: size of benefit Pre-integration: fixed costs = operating profit = area “a+b” Post-integration: operating profit = b+c ERGO: Breakeven subsidy = a-c Net Benefit: b+c+a-c=a+b euros Price Mark-up COMP Demand curve BEFT E’ E’ p’ a AC A A pA pA A b c MC 2n’ Number of firms Sales per firm Total sales x’ C’ CA xA= 2CA/2n’

Restructuring prevention: welfare impact Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Restructuring prevention: welfare impact Change producer surplus = zero (profit is zero pre & post) Change consumer surplus = a+d Subsidy cost = a-c (producer’s loss) Total impact = a+d – (a-c)= d+c euros Price Mark-up COMP Demand curve BEFT E’ E’ p’ a AC d A A pA pA A b c MC 2n’ Number of firms Sales per firm Total sales x’ C’ CA xA= 2CA/2n’

Does it make sense to subsidize? Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Does it make sense to subsidize? Static welfare gains resulting from inefficiency of imperfect competition, i.e. differences between average and marginal costs Higher production = higher welfare under increasing returns to scale However, subsidizing loss-making enterprizes creates dynamic losses -> reduced innovation and technological progress

Only some subsidise: unfair competition Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Only some subsidise: unfair competition If Foreign pays ‘break even’ subsidies to its firms All restructuring forced on Home 2n’ moves to n”, but all the exit is by Home firms Unfair Undermines political support for liberalisation

EU policies on ‘State Aids’ Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU policies on ‘State Aids’ 1957 Treaty of Rome bans state aid that provides firms with an unfair advantage and thus distorts competition. EU founders considered this so important that they empowered the Commission with enforcement.

Theory and Politics of European Integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU Trade Policies

Trade: Facts Two-thirds of EU25 exports are to other EU25 nations. Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Trade: Facts Two-thirds of EU25 exports are to other EU25 nations. More than 90% of this is actually among the EU15 trade (10 new Member States are fairly small economically). Add all other European nations, three-fourth of Europe’s trade is within Europe. North America and Asia are the EU25’s main markets outside Europe, each accounts less than one-tenth of EU exports. Africa, Latin America and the Middle East are not very important. The pattern on the import side is very similar Rounding off, three-fourth of EU imports are from Europe, with the fourth quarter split into two more or less even groups of nations – Asia, and all other nations. Trade with non-European nations is balanced.

Facts: Patterns of Trade Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Facts: Patterns of Trade

Facts: Differences across Member States: non-EU trade Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Facts: Differences across Member States: non-EU trade

Composition of imports and exports, aggregate trade Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Composition of imports and exports, aggregate trade Manufactured goods 90% of total exports (half of all exports being machinery and transport equipment). Import side, two-thirds on manufactured goods. EU-25 is a big importer of fuel (18 % of imports). Only 6% food and agriculture. Other types of goods play a relatively minor part in the EU’s trade.

Composition of imports and exports, aggregate trade Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Composition of imports and exports, aggregate trade

EU External Trade Policy: Institutions and trade in goods Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU External Trade Policy: Institutions and trade in goods Recall: Customs Union requires common trade policy Trade policy among the ‘first pillar’ since Rome Treaty European Commission has the right to set tariffs and negotiate on trade issues at WTO EC Trade Commissioner negotiates, has a mandate assigned by the council of ministers Council has final say

EU Trade Policies: other areas Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU Trade Policies: other areas World trade negotiations involve far more than trade in goods. Trade-related intellectual property rights (TRIPs) Trade-related investment measures (TRIMs), Service trade Technical Barriers to Trade (TBTs), trade facilitation, etc. Treaty of Rome only gave Commission power over trade in goods Treaty of Nice (& Amsterdam) extended Commission’s authority to some aspects of Services trade and TRIPs, & made QMV the rule in Council on such matters.

Contingent protection Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Contingent protection WTO allows members to raise tariffs to: Counter ‘unfair’ trade practices, e.g. Antidumping measures, e.g. penalty tariffs Countervailing duties, e.g. ‘voluntary agreements’ of ‘price-undertakings’ Firms charge higher prices, but EU loses tariff revenue Provide temporary protection “safeguards” Widely applied by US and EU The various WTO articles on these require a procedure; in EU the Commission is in charge of these procedures, but the final decision is subject to QMV approval of the Council.

EU External Trade Policy: MFN Tariffs Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU External Trade Policy: MFN Tariffs MFN tariff structure reflects comparative advantage of EU industries Low tariffs in manufacturing Exception: textiles and clothing High in food and agriculture, especially diary products Interest groups matter

EU’s MFN tariff structure (Common External Tariff – CET) Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU’s MFN tariff structure (Common External Tariff – CET)

EU External Trade Policy: Preferential Agreements Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU External Trade Policy: Preferential Agreements EU has special deals with 139 nations; often more than one per partner. Each can be very complex ...

EU External Trade Policy Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU External Trade Policy

Preferential agreements: logic Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Preferential agreements: logic ‘Hub’ and ‘Spoke’ System EU is a regional ‘hub’ in ‘hub’ and ‘spoke’ system of trade deals Morocco is a typical case: 71% of exports to EU, but only 1% of EU imports from Morocco Asymmetry gives EU high leverage in dealing with these nations

EU External Trade Policy: European circle Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU External Trade Policy: European circle European-Mediterranean area: West, Central and Eastern Europe = Single market in industrial goods; EU + EEA + Swiss bilateral agreements Euro-Mediterranean Association Agreements: Morocco, Algeria, Tunisia, Egypt, Israel, the Palestinian Authority, Lebanon, Jordon, Syria and Turkey. Asymmetric (EU cuts its tariffs faster) FTAs in manufactures, by 2010. Turkey unilaterally in Customs Union in manufactures.

EU External Trade Policy: European circle (cont.) Theory and Politics of European Integration Lecture 7 Trade and Competition Policies EU External Trade Policy: European circle (cont.) European-Mediterranean area (cont.): Asymmetric dependence (e.g. 70% of Morocco’s exports to EU, but <1% of EU to Morocco) EFTA’s “FTA union” with EU; EFTAns mimic EU to avoid discrimination against EFTA-based exporters.

Former Soviet Republics & Western Balkans Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Former Soviet Republics & Western Balkans Partnership and Cooperation Agreements (PCAs). These are GSP+ (GSP=Generalised System of Preference). Russia, Ukraine, Georgia, Belarus, Armenia, Azerbaijan, Kazakhstan, Kyrgyzstan, Moldova and Uzbekistan. Asymmetric tariff reduction without requiring PCA partners lowering theirs. Stabilisation and Association Agreements (SAAs). Former Yugoslavian states. Croatia has started membership; others likely to follow.

Preferential arrangements with former colonies Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Preferential arrangements with former colonies Colonial preferences conflicted with Common External Tariff EU made exception for these nations to avoid imposing new tariffs; signed “unilateral PTAs” Yaoundé Convention and Arusha Agreement When UK joined 1974 exceptions extended to many Commonwealth nations. “ACP nations” (Africa, Caribbean & Pacific); the new agreement = Lomé Convention. Duty-free but subject to quota for sensitive items (sugar, banana, etc.)

Preferential arrangements with former colonies Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Preferential arrangements with former colonies These didn’t help the ACP nations much c.f. Asian success without tariff preferences When Lomé Convention renewed in 2000, the EU and the ACP nations agreed to modernise the deal Cotonou Agreement; eventually reciprocal free trade stepwise reduction of tariffs on ACP nation side general outline of principles details fixed in bilateral Economic Partnership Agreements (EPAs)

Generalised System of Preferences (GSP) Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Generalised System of Preferences (GSP) 1971 GATT provision allows tariff preferences. EU grants GSP to almost all poor nations. General GSP. “Super-GSP” more generous on market access. ‘Everything but Arms’ (EBA) for least developed nations.

Generalised System of Preferences (GSP) (cont.) Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Generalised System of Preferences (GSP) (cont.) On paper, EBA grants zero-tariff access all goods, except arms and munitions. Goods in which these nations’ are most competitive are in fact excluded from the deal. Tariffs on bananas, rice and sugar – products where these poor nations could easily expand their EU sales – are to come down only in the future. Moreover, even though all tariffs on these items will be gone by 2009, the exports quantities are limited by bilateral quotas. 49 nations qualify for EBA in principle in 2005.

Mexico, Chile, and South Africa, done. Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Non-regional FTA Mexico, Chile, and South Africa, done. Ongoing with Mercosur and the Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates).

Finally, non-preferential trade Theory and Politics of European Integration Lecture 7 Trade and Competition Policies Finally, non-preferential trade Only 6 main nations: US, CAN, JAP, AUS, AT, KOR But about 1/3rd of EU imports are not granted some sort of preferential treatment

Theory and Politics of European Integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies NEXT LECTURE December 12, 2013