Economic and Social Cohesion in Europe

A New Objective

Achille Hannequart

• Publisher: Routledge
• Year: 1992
• Print ISBN:
  9780415066174
• eBook ISBN:
  9781134962884
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

With discussions of a full internal market within the EC finally reaching fruition, and regular intergovernmental talks advancing the ideas of economic, monetary and perhaps eventually political union, economic and social cohesion has become a major objective of Community policy.Regional disparities remain a hard fact of Community life. Although th

Part I: Economic and social cohesion: Community policies and the Structural Funds

Chapter 1: Policy requirements for regional balance in economic and monetary union

Rory O’Donnell

This chapter considers the regional effects of economic integration and the range of policies which are available to achieve regional balance in a European economic and monetary union. The first section identifies some conflicting views on the regional effects of integration and argues that benefits of market completion are likely to be unevenly distributed —with the greatest benefits acccruing to regions in which industries with economies of scale and highly innovative sectors are most prevalent. In addition, it is argued that it would be dangerous to assume that macroeconomic shocks with asymmetric regional effects will not occur in economic and monetary union (EMU). The second section is concerned with the broad outlines of a Community system of policy to achieve regional balance. Four possible types of Community policy to assist convergence are identified—structural policies, macroeconomic co-ordination, budgetary transfers and differential application of other Community policies—and their merits assessed. The central conclusion is that all four types of policy are necessary in the Community now. In the final section these arguments are used to assess the discussion of cohesion and cohesion policies in the recent Delors Report on Economic and Monetary Union.

THE REGIONAL EFFECTS OF INTEGRATION

The regional distribution of economic activity and income in the Community is clearly of great importance to all member states and regions. Not surprisingly, it has played a significant role in deliberations on the costs and benefits of economic and monetary union.

In textbook discussions on this subject, it is considered that the allocation of economic activity between the member states would differ depending on whether the states had formed a customs union, a common market, or an economic and monetary union. This is because, in the textbook approach, the degree of mobility of goods, labour and capital is distinctly different in each model. This difference is often considered by some to have implications for the pattern of economic activity in different states of a monetary union. In particular, it has been argued that adherence to a single monetary standard will impose costs on economically weaker states and regions. We discuss this question in more detail later. The relevant point is that, given these textbook definitions, the forces influencing the pattern of activity are likely to be different in the three cases—customs union, common market and economic and monetary union.

In a recent assessment of the relative regional implications of a customs union and an economic and monetary union, Ireland’s tripartite National Economic and Social Council did not place major emphasis on the macroeconomic dimension of the regional effects of EMU. In particular, in its Report Ireland in the European Community, it did not place great emphasis on the traditional argument that EMU would be especially difficult for weaker regions because of the deflationary effects of adhering to a uniform monetary standard. Consequently, it departed somewhat from the textbook view in arguing that there are a number of reasons why the effects of market forces in shaping the pattern of activity across various member states and regions may not, in fact, be very different at different stages of integration.

It is most important to stress, however, that this view did not imply that no regional difficulties or imbalances are likely to arise in the integration process viewed as a whole. In fact, there is every reason to believe that the effects of integration have been, and will be, regionally uneven and that other forces in the world economy also create regional imbalances. Consequently, in formulating a policy system for the European Community, an important question is: what are the policy requirements for regional balance in a European economic and monetary union? In this section we briefly discuss the conflicting arguments concerning the regional effects of economic integration and proceed in the next section to indicate what policy approaches and systems seem necessary to secure regional balance.

Tendencies for regional convergence and divergence

One reason why the textbook theory of economic integration viewed monetary integration as more likely to exacerbate regional problems was that the relative costs and benefits of a customs union, a common market and an economic and monetary union were assessed by applying the traditional theory of international trade. That traditional theory was based on very restrictive assumptions and these had a major role in generating the benign view of trade in the conventional literature. In recent years, significant developments have occurred in the theory of international trade and integration. The new approaches take account of important real world phenomena such as economies of scale, external economies, the market power of firms and learning by doing. The important point is that these new approaches alter somewhat our views of the gains from trade and integration (see NESC 1989).

Limitations of space preclude a detailed discussion of how these new trade theories alter our views of the gains from trade. However, for a reason that will emerge presently, the issue is an important one and a brief summary of the position is warranted.

In general, the new approaches to trade indicate that the overall gains from trade and integration are potentially larger than in the conventional analysis. In addition, the new theories provide some reasons to believe that the costs of adjusting to free trade will be more evenly distributed between regions, and some reasons why the long-run benefits of trade will be less evenly distributed. Krugman summarises this difference by saying that trade based on economies of scale, the market power of firms and product differentiation ‘probably involves less conflict of interest within countries and more conflict between countries than conventional trade’ (Krugman 1987; this statement is explained in a non-technical way in Chapter 2 of NESC 1989).

The theory of regional economics contains a formidable list of reasons why advanced economic activity will tend to concentrate in certain regions. Among the facts making for concentration are economies of scale, economies of agglomeration and the division of labour, advantageous labour market characteristics, innovation leadership and external economies associated with the generation of knowledge. There are also forces for diffusion of manufacturing and other activities. Among these are the emergence of a new spatial division of labour, improvements in transport and telecommunications in peripheral regions and congestion in central regions. However, our analysis suggests that, in the coming years, these forces, while they will certainly be at work, will not be sufficiently strong, nor sufficiently convergence-generating, to overcome the forces for concentration.

Now, this general view of regional developments is one which finds a clear echo in the theory of trade and the study of European market integration. Robson (1987) says that ‘the formation of an economic grouping is likely to enhance the forces of polarisation at country level’. Eaton (1987) considers that ‘the benefits of trade may not be shared symmetrically…with the country exporting the commodities whose production involves greater scale economies typically benefitting more’. Krugman (1987) tells us that while scale economies and oligopoly increase the potential gains from trade, ‘they also open up some possible ways in which trade can have adverse effects’. Padoa-Schioppa (1987), in his important study of the Community system, considers that ‘the spatial distribution of such gains is less certain and is unlikely to be even’. Finally, and specifically on the completion of the internal market, Pelkmans and Robson (1987) say that the structural problems of the less-advanced member states ‘will almost certainly be accentuated by an approach to fully-fledged industrial market integration’.

A different view of the likely regional distribution of gains from integration generally, and internal market specifically, was put forward in the ‘Cecchini Report’ (Emerson et al. 1988). There it is said that the traditional theory of international trade predicts vicious and virtuous cycles of regional decline and growth, and that the new approach predicts a more even distribution of the gains from trade and integration (pp. 139–40). This argument assumes considerable importance because it is restated by President Delors (1989b). Indeed, having stated the view, Delors refers the reader to ‘The economics of 1992’ ‘for a fuller presentation of these arguments and further references’ (Delors 1989b:83).

While there is some truth in the idea that in the new theories of trade, regional effects are less predictable, there is, in my view, no basis for the statement that an uneven distribution of benefits and costs is less likely. It can be shown that the view put forward in the Cecchini Report, and restated by Delors, is based on a misrepresentation of the traditional trade theory and a highly selective account of the new approach (see NESC 1989:344–8). In fact, the new theory of trade takes account of those very features of the modern economy—increasing returns, external economies, the advantages of experience, monopoly power and the barriers to entry created by high capital and research and development (R&D) requirements—which were originally used to explain regional inequality and divergence. Contrary to the impression created by the Cecchini Report, it is those new theories which include the possibility of cumulative processes of growth and decline.

Another argument advanced by Delors in his essay on the regional implications of economic and monetary integration is that changes in technology and demand make concentration of economic activity less likely. He argues that, because of technical change, ‘transport costs are becoming, on average, less important in the location of industrial production’. To some extent, this focus on transport costs reflects an equal emphasis on infrastructure, distance and access transport by some of those who argue that integration will bring about further concentration of economic activity (Doyle 1989:75). However, two wrongs do not make a right; and the argument that technical and organisational change unambiguously reduce the forces making for geographic concentration of economic activity is highly debatable. For example, in discussing the regional implications of 1992, Pelkmans and Winter (1988) note that ‘Although improved communications reduce the economic distance between the periphery and the core, they also currently generate economies of agglomeration’.

Overall, a more detailed consideration of the issues and a wider reading of the literature strongly suggests that it is too simplistic to infer that radical technical telecommunications and transport improvements, because they technically reduce the significance of distance, also reduce its overall economic significance, or cause a wider dispersal of activity and a convergence of regional economies. There is considerable evidence that the effects of the new technologies on the scale of firms and plants is highly complicated and depends on very specific features of the industry. It should come as no surprise that a similar conclusion applies to the effect of technical change on the location of activity (see Wadley 1986; Padoa-Schioppa 1987; Ergas 1984; Kaplinsky 1984; Borris et al. 1987; Sayer 1986; Cooke and Imrie 1989; Perez 1983; Dosi 1988 and Stopford and Turner 1985).

After consideration of all the arguments, our general conclusions must be that the long-run benefits of market completion are likely to be unevenly distributed—with the greatest benefits accruing to regions in which industries with economies of scale and highly-innovative sectors are most prevalent. Consequently, completion of the internal market should not be expected to narrow the income disparities between regions in the EC, let alone bring about convergence.

Having rejected President Delors’s view on the likelihood of concentration of economic activity, I should add that one of the central propositions in his essay, ‘Regional Implications of Economic and Monetary Integration’, seems absolutely correct. He correctly took issue with the view that the existence of substantial structural differences between European regions was a reason not to proceed to economic and monetary union, as was suggested in some quarters. In advising their governments, social partners took a very similar view to President Delors and the Delors Committee on this issue. However, this has implications for the kinds of policies and policy frameworks which are needed in EMU if regional imbalances are to be minimised (see below).

Monetary union and the loss of exchange rate autonomy

It was stated at the beginning of this section that, in assessing the regional distribution of economic activity and income, little emphasis would be put on the regional effects of loss of exchange rate autonomy in an economic and monetary union. It is now necessary to say something about this issue.

The possible cost of losing discretion over the exchange rate was, for many years, the major issue in analyses of the costs and benefits of economic and monetary union (Corden 1972; Coffey 1977; Robson 1987). It is clear that, to some extent, the issue of whether monetary union would impose costs on weaker regions turns on the question of whether exchange rate devaluation can address the real problem of these regions. Initially, this was widely thought to be the case. However, the effectiveness of devaluation was subsequently questioned for both theoretical and empirical reasons. It is important to distinguish between the theoretically—and empirically-based scepticism about the ability of exchange rate devaluation to increase output and employment. The theoretically-based scepticism derived, in many cases, from adherence to the notion that the real economy in each country has a natural tendency to full employment and, consequently, it would be logically impossible for devaluation of the exchange rate, or any other macroeconomic policy, to increase output and employment. This is not the position which underlies the argument of this author. While we must share this scepticism about power of exchange rate policy to address regional problems, we must also note that both the theory and evidence on exchange rate changes and their real effects, if any, have, once again, become quite uncertain.

In the face of this considerable uncertainty, consideration of the costs and benefits of monetary union for a weaker region should take the following factors into account:

1. 1 an adequately structured and rationally organised economic and monetary union would have a set of budgetary mechanisms which, because of their interregional redistributive effects, would cushion regions from macroeconomic fluctuations and shocks at least as effectively as exchange rate movements do (see below);
2. 2 without necessarily rejecting the notion that monetary integration, specifically adherence to a hard currency peg, can impose costs on weaker regions, a modern and flexible approach to trade and integration qualifies traditional views of the pattern and timing of the overall costs and benefits of integration. Specifically, it suggests that even free trade can generate large and unevenly distributed costs and benefits in both the short and long run. At the very least, this would take the emphasis off monetary integration as the step which raises problems for weaker economies;
3. 3 many of the major forces which cause long-run regional concentration and diffusion will operate on an open economy, regardless of the monetary regime in place.

These points play an important role in the argument that leaders in less-developed member states, and states with serious regional problems, should strongly support moves to build a European economic and...

Table of contents

• Cover Page
• The Trans European Policy Studies Association (TEPSA)
• Title Page
• Copyright Page
• Tables
• Contributors
• Foreword
• Abbreviations
• Economic and social cohesion and the Structural Funds: An introduction
• Part I: Economic and social cohesion: Community policies and the Structural Funds
• Part II: The Structural Funds: Implementation and efficiency
• Appendix: Legislation