Working Paper: CEPR ID: DP1308
Authors: Richard E. Baldwin; Rikard Forslid; Jan Haaland
Abstract: This paper studies the investment creation and investment diversion effects of the EU's Single Market programme (EU92). We find suggestive, but not conclusive, evidence indicating that EU92 may have led to investment diversion in the economies of the European Free Trade Association (EFTA) and investment creation in the EU economies. We argue that a simple mechanism, based on the derived demand for capital can account for this. Discriminatory liberalization shifts production from excluded countries to the integrating region. Since EU92 focused on tradable sectors and these are capital intensive, the production shifting raises the rental rate in the integrating regions, lowering it elsewhere. This leads to investment creation and diversion. Results from our simulations show that investment diversion does occur for the EFTA6 (namely, the EFTA6 steady-state capital stock drops by two-thirds of a percent) when the EU's liberalization (EU92) involves market integration in addition to real trade cost reduction. When EU92 is extended to include the EFTA6, EFTA6 capital stocks rise by almost 5%. In terms of real income, the difference between the EFTA6-included and EFTA6-excluded cases is quite large for the EFTAns amounting to 5.5% of GDP. In all cases, the EU experiences investment creation (equal to approximately one-fifth of a percent of their initial capital stock) and real income gains (equal to 1.75% of GDP). The effects on the United States and Japan are trivially small, but mostly negative in terms of capital stocks and real income.
Keywords: investment creation; investment diversion; single market programme
JEL Codes: F12; F15; F17; F43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| EU92 programme (O52) | investment diversion in EFTA economies (F21) |
| EU92 programme (O52) | investment creation in EU economies (O52) |
| production shifting from EFTA to EU regions (F15) | investment creation in EU economies (O52) |
| EU92 programme (O52) | changes in production (E23) |
| EU92 programme (O52) | changes in rental rates for capital (D33) |
| investment diversion in EFTA economies (F21) | decrease in capital stocks in EFTA (F21) |
| EU92 programme (O52) | real income gains for EU (O52) |