Market Integration, Scale Economies and Labor Market Imperfection in an Applied General Equilibrium Model

Transcription

1 ANNALES D ÉCONOMIE ET DE STATISTIQUE. N Market Integraton, Scale Economes and Labor Market Imperfecton n an Appled General Equlbrum Model Emmanuel PETIT * ABSTRACT. Ths paper provdes general-equlbrum estmates of the welfare gans and unemployment changes that may be expected from the sngle European market. The nvestgaton uses a multcountry, multsector appled model wth mperfecton. The analyss s performed assumng three alternatve wage determnaton mechansms (flexble wages, wage ndexaton and effcency-wage model). Labor market mperfecton allows for the exstence of nvoluntary unemployment rate. The man contrbuton n the paper s that economc ntegraton could mply deteroraton n employment n Europe. Processus d ntégraton, économes d échelle et mperfecton du marché du traval dans un modèle d équlbre général applqué RÉSUMÉ. Cet artcle évalue les conséquences sur le ben-être et l emplo du processus d ntégraton européen. On utlse un modèle d équlbre général applqué mult-pays, mult-sectorel en concurrence mparfate. Sur le marché du traval, dfférentes hypothèses sont formulées (plen-emplo, rgdté des salares réels et salare d effcence), ce qu permet d ntrodure un taux de chômage nvolontare. L artcle montre que le processus d ntégraton s accompagne d une détéroraton de la stuaton de l emplo en Europe. * E. PETIT: Unversté de Lmoges. Comments by anonymous referees are gratefully acknowledged.

2 1 Introducton Trade lberalzaton n a group of countres or an economc regon, acheved by remowng tarff of non-tarff barrers, s a major feld of research n nternatonal economcs. Appled general equlbrum models are partcularly approprate n ths feld snce the analyss of the behavor of dfferent types of agents n many countres s requred. The stake n economc ntegraton s hgh: one has to determne the output and employment perspectves mpled by trade lberalzaton n a common economc space. Recently, many attempts to provde general equlbrum welfare estmates of Europe s move to a unfed market 1 have shown that t was necessary to gve up perfect competton assumptons when analyzng market ntegraton. These models have therefore allowed a renewal of ths feld of research ntroducng mperfect market structures. However, the analyss of ntegraton needs to be enrched wth work on non-clearng labor markets. For ths reason, we buld a multcountry multsector appled general equlbrum model wth endogenous mperfect market structure n the labor market. More precsely we ntroduce an nvoluntary unemployment rate that s determned endogenously n an effcency-wage framework. Our model allows consderng new features on the consequences of ntegraton on employment n Europe. Wth trade lberalzaton, the usual scenaro tells us that the ratonalzaton effect à la HARRIS [1984] and the pro-compettve phenomena ental a total output ncrease n the major European countres. When ntroducng an mperfecton n the labor market, ths output ncrease may not be hgh enough to ensure employment recovery n Europe. Our am s to measure these effects and analyze how they combne to affect the level and pattern of welfare, producton, and employment. The paper s organzed as follows. The frst secton presents the structure of the basc general equlbrum model upon whch the analyss of economc ntegraton s based. Ths basc model assumes flexble wages and fullemployment (2). In secton three, we gve up ths perfect labor market framework and ntroduce two alternatve wage-determnaton assumptons. These assumptons allow estmatng the consequences on employment of the completon of the sngle European market (3). Fnally, the calbraton procedure and the results of our numercal experments are reported n secton four (4). The paper ends wth a bref concluson. 1. SMITH and VENABLES [1988], GASIOREK, SMITH and VENABLES [1992], BURNIAUX and WAELBROECK [1992], MERCENIER [1995]. 198

3 2 The Basc Model We here provde only a bref unformal descrpton of the basc model (see Appendx A for a formal descrpton). The model we use s a statc European economy model consstng n fve countres/regons: France (FRA), the Federal Republc of Germany (DE), Great-Brtan (GB), Italy (ITA) and the rest of EEC10 (REEC). Each country has heght ndustres (see table 1), of whch one s treated as perfectly compettve,. In ths compettve sector, we assume that commodtes are dfferentated n demand upon the bass of ther geographcal orgn (the ARMINGTON assumpton). The other seven ndustres,, operate wth ncreasng returns to scale n non-compettve markets, each frm producng a dfferent commodty. Fnal demand decsons are made n each country by a sngle representatve utlty-maxmsng consumer. A detaled country and sector-specfc system of prce-responsve ntermedate demands s specfed. All components of demand fnal as well as sectorspecfc ntermedate recognze dfferences n products from ndvdual olgopolstc frms à la DIXIT and STIGLITZ [1977]. Both producton factors are assumed to be moble across sectors 2, wth country specfc labor and nternatonal captal moblty. From a theoretcal pont of vew, the concept of general equlbrum used here s a compromse n terms of nformatonal requrements between the prmtve conjectural COURNOT-NASH equlbrum poneered by NEGISHI [1961] and the objectve COURNOT-NASH-WALRAS equlbrum as frst ntroduced by GABSZEWICZ and VIAL [1972]: non-compettve frms are assumed to maxmze ther profts usng the objectve (or true ) demand curves they face, but also to neglect the feedback effect of ther decsons on ther profts through ncome (the FORD effect). Ths partal equlbrum compromse, advocated among others by HART [1985], play a major role n reducng the rsk of nonexstence of equlbrum, as stressed by ROBERTS and SONNENSCHEIN [1977] 3. Moreover, t provdes realsm to the analyss as well as computatonal advantages. In the appled general equlbrum lterature, ths approach has been adopted by MERCENIER [1995]. Due to prevous results obtaned n the lterature, we use ths general equlbrum concept assumng that the statc game played by frms n mperfectly compettve sectors s Nash n output (à la COURNOT 4 ). Industry structure s assumed to be fxed n the short run (the number of frms remans constant); olgopolstc frms can therefore experence nonzero profts. In 2. Ths assumpton wll be wthdrawn later for the labor market n secton As a matter of fact, n general equlbrum models, exstence proofs can only be gven under very specfc assumptons on the behavour of consumers and producers whch are generally too restrctve for appled modellng. 4. Though the model may be smulated wth BERTRAND-NASH competton, the results of the numercal experments show that ths case s of lttle nterest, because frms then enjoy almost no power to prce dscrmnate. APPLIED GENERAL EQUILIBRIUM MODEL 199

4 the long run, however, the entry and ext of compettors n a Chamberlnan fashon ensure that these rents vansh (varable market structure). The scope of our nvestgaton requres a precse defnton of economc market ntegraton. Followng SMITH and VENABLES [1988], we assume that there are no tarff barrers remanng n Europe, or at least that they are small and can therefore be neglected. In contrast, sgnfcant nontarff barrers (NTBs) reman such as norms, government-procurement polces, securty regulatons, etc. These barrers prevent consumers from equalzng cross-border prces through arbtrage, and frms are able to prce dscrmnate among segmented domestc markets. The ultmate goal of the 1992 programme s to restore cross-border arbtrage by elmnatng all forms of NTBs, forcng frms to act on an ntegrated EEC-wde bass and charge the same prce wthn the Communty. The dffculty n descrbng the ntegraton process stems from complex formalsaton and quantfcaton of NTBs n an appled general equlbrum model. The approach developed here s based upon the analyss of MERCENIER [1995]. Indeed, hs modelng strategy conssts n treatng these NTBs as latent varables, underlyng the exstence of prce-dscrmnaton opportuntes for frms among natonal clents before trade lberalzaton s enforced. Ths beng admtted, usng the data set makes t possble to nfer the prce-system consstent wth the optmal prce-dscrmnaton strateges of olgopolstc frms, and to nterpret these as resultng from the mplct structure of non-tarff barrers. The experments then conssts n enforcng ndvdual frms to move to a sngle prcng rule determned on the bass of ther average EEC-wde monopoly power, and to nterpret ths behavoral change as the optmal strategc reacton to the dsappearance of the never-explctly-modeled NTBs. In ths model, we adopt ths type of formalsaton. Ths modelng strategy gves prorty to the descrpton of complex market ntegraton mechansms (economes of scale, dfferentaton of products, degree of concentraton, etc.), hardly compatble wth complete formalsaton of explct NTBs. 3 Labor Market Imperfectons: Introducng Prce Rgdty In the prevous secton, we assumed the exstence of compettve nput markets mplyng that producers consder the prce of factors as gven. In ths case, the economy s characterzed by full-employment of nputs: supples and demands adjuts ruled by factors prce varatons. Of course, ths s an extreme unrealstc representaton of European economes. There s therefore crucal need for mprovng the analyss of ntegraton n appled general equlbrum models wth mperfect competton wth work on non-clearng labor markets. A more realstc approach s to ntroduce mperfect nput markets to reflect stylzed features n most ndustralzed countres. In partcular, a general equlbrum model should be able to capture the effects of ntegraton on employment. 200

5 In order to allow for a gap between supply and demand on the labor market, the structure based upon the walrasan model needs to be relaxed. In fact, we can no longer assume that factor prces clear the labor market. On the contrary, we have to assume that adjustments are constraned by a degree of prce rgdty. In ths model, two alternatve rgd prce assumptons are ntroduced: a real wage rgdty procedure (1); a prce-fxng mechansm based on ndvdual behavor wth the determnaton of effcency wages (2). By ntroducng alternatve assumptons on the nput market, the model s bult as a structured successon of mprovng experments. Our am s to explore the mplcatons of each assumpton and to dentfy the role of assumptons n determnng the outcome of smulatons Stylzed Facts and Structural Constrants: Rgd Real Wages Here, we ntroduce constrants to relax the perfect factor moblty assumpton and to assume real wage rgdty n a rather ad hoc manner. In the short term, the mplct tme scale behnd the assumpton of fxed ndustry structure (the number of frms on each market s exogenous) dentfes a short-run equlbrum consstent wth the rgdty of labor moblty assumpton. In contrast, when the two assumptons of entry/ext and rgd real wages are smultaneously mplemented, t s dffcult to justfy both the creaton and destructon of new frms whch takes tme and the fxty of real wages. So, we specfy labor market assumptons whch enable us to lnk the short-run equlbrum wth that of the long run 6. In the short run, real wages are assumed to be fxed and the level of employment s thus determned endogenously. We ntroduce ths assumpton for the case of fxed ndustry structure by substtutng the followng block to the labor market balance equaton (see equaton A10 n appendx A): where, denote, respectvely, the consumer prce ndex and the labor unt cost n country, wth standng for the set of all countres. The symbol 0 refers to reference year values. We then assume that, n the long run,.e., when complete adjustment of ndustry structure s acheved, wages adjust to mantan employment at the level nherted from the short run. 5. As ponted out by an anonymous referee, by ntroducng labour market assumptons, we modfy general-equlbrum effects (specfcally on the demand sde) and consequently the results of these experments. 6. Ths treatment s, to a certan extent, smlar to the one adopted by ERLICH, GINSBURGH and VAN DER HEYDEN [1987] n a two-perod framework and has been used also by MERCENIER [1995] and AKITOBI [1994]. APPLIED GENERAL EQUILIBRIUM MODEL 201

6 The drawback of ths approach s that, n fact, t doesn t allow takng long-term consequences of ntegraton nto account, even f the model used s dynamc. Indeed, the long-term smulaton assumes that structural constrants on the labor market are elmnated and cannot provde a theoretcal explanaton of ther presence. However, the most severe crtcsm s that real wage rgdty s assumed, a pror, nstead of resultng from endogenous optmzaton behavor. In fact, ths modelng specfcaton may be consdered as ad hoc snce no theoretcal element can justfy ths rgdty. So, our am s to represent labor market rgdtes based on mcroeconomc foundatons thereby embeddng the basc multsector model nto a wage-effcency framework An Alternatve Approach of Labor Market Imperfecton: The Labor Turnover Model Our am here s to ntroduce an endogenous theory of labor market mperfecton n the basc multsectoral, multcountry model. We use the mcroeconomc foundatons of the turnover model frst developed by STIGLITZ [1974]. Ths modelng assumpton has the advantage of provdng a helpful tool to descrbe labor market mperfectons whch s fully consstent wth walrasan mcroeconomc foundatons. Indeed, the turnover model s based upon ndvdual optmzaton behavor. Also, of all the effcency wage models, the turnover model s possbly the oldest, the most ntutve, and one of the most wdely regarded as beng a major cause of unemployment. Here, we only provde the man elements of ths theory allowng us to ntegrate an mperfect labor market framework nto our basc model. Wth ntal partton between compettve and mperfectly compettve sectors, we also assume that the labor market s parttoned nto two subsets of compettve and non-compettve labor markets. Besdes, labor moblty n the global market n each country s assumed to be mperfect. In the compettve ndustry, and n each country, compettve wages are assumed to adjust nstantaneously to ensure full-employment. In non-compettve ndustres, the ntroducton of a turnover cost n total producton cost of olgopolstc frms acts as an ncentve to arbtrate: hgher wages are offseted by lower tranng and hrng costs. The result s the determnaton of an effcency wage level n non-compettve sectors that mply an equlbrum level of (nvoluntary) unemployment. Because of avalablty constrants on wage dfferental data, we assume the exstence of a sngle nomnal wage rate for all non-compettve sectors n each country ( ). In ths case, labor costs are equal to wage payments plus tranng and hrng costs, and therefore the total labor cost of the representatve non-compettve frm of sector s: = wage payments + turnover costs = 7. Another possblty would be to ntroduce wage-fxng mechansms such as Oswald s [1982] type of barganng between unons and employers (on ths pont, see the analyss of GELAUFF et al. [1990]). Also, DE MELO and TARR [1993] ntroduce labor unons selectvely nto a standard CGE model wth mperfect competton. 202

7 where s the quantty of labor used by the producer n sector n country ; are tranng-hrng costs per worker that are assumed, for smplcty, to be constant; s the qut rate,.e., the percentage of the labor force quttng at any tme; s the wage rate pad n non-compettve sectors n country. The turnover-effcency-wage model hghlghts the turnover rate to explan worker behavor n the economy. The turnover rate s a decreasng functon of wage rate dfferental between non-compettve sectors and the compettve sector. Therefore, there are ncentves for each frm n the noncompettve sectors to pay hgher wages (compared to compettve wages). Indeed, f there s a large wage dfferental between the non-compettve wages and the compettve wages, workers wll be encouraged to stay n the frm and not to qut. On the contrary, a low wage dfferental s an ncentve for workers to mgrate. Moreover, when an ndvdual s hred by a frm, there s some probablty that he may be unsutable for the job (so wll be fred) or that he wll dslke the job and therefore seek another one. The ease wth whch ths s accomplshed depends on the unemployment rate. So, t appears clearly that the unemployment rate n the mperfect labor market ( ) and the wage dfferental ( / ) belong to the labor turnover functon: We form specfc assumptons about the functonal form of the qut rate functon. More precsely we mpose some restrctons ou our qutrate functon (convexty of wth ts arguments ( ) and ). Theoretcally, there s a relatonshp between the magntude of wage dfferental and the equlbrum rate of unemployment. Indeed, f there are large dfferences n wage rates between the non-compettve and compettve sectors, labor wll mgrate from the compettve to the mperfect competton sectors. More ndvduals wll mgrate f they can fnd jobs, and ths leads to an ncrease n unemployment n non-compettve ndustres. In fact, unemployment tends to dscourage further mgraton. We can wrte ths postve relatonshp as, APPLIED GENERAL EQUILIBRIUM MODEL 203

8 FIGURE 1 Unemployment rate and wage dfferental. The consdered qut rate functon s assumed to be dentcal n all non-compettve ndustres. However, due to our country labor moblty assumpton, we assume that there s a qut rate functon n each country ( ): Accordng to the basc assumptons of the turnover model, the qut-rate functon s, for a gven parameter, a decreasng convex functon of the unemployment rate n all non-compettve sectors 8. Qut rate worker behavor depends on the dfference between the compettve and non-compettve wages: we assume that an ncrease n the wage dfferental decreases the wage dfferental senstvty of the qut rate. 8. Indeed, we have, and,

9 FIGURE 2 The qut rate functon. It mples that the wage dfferental elastcty of the qut rate ( ) s an ncreasng (negatve) functon of ( ) such as: such that FIGURE 3 Elastcty of the qut rate wth respect to the wage dfferental. In ths case, for a low ntal wage dfferental, a varaton n ths dfferental wll lead to a relatvely low mgraton. Equally, t can be sad APPLIED GENERAL EQUILIBRIUM MODEL 205

10 that an ncrease n the unemployment rate decreases the senstvty of the qut rate to the unemployment rate. Thus, the elastcty of the turnover rate wth respect to the unemployment rate s an ncreasng (negatve) functon of : such that FIGURE 4 Elastcty of the qut rate wth respect to the unempolyment rate. For a gven qut-rate functon, the frm seeks to mnmze the labor cost per employee, We assume that wage determnaton arses from monopolstc competton n all non-compettve ndustres: each producer mnmzes ts total labor costs takng the wage rate of other frms, as well as the compettve wage rate and the qut-rate functon, as gven. Ths yelds the followng frst-order condton: when the wage rate pad n non-compettve sectors,, depends only on the unemployment rate n the economy. The relatonshp between the optmal wage rate chosen by the frm and the unemployment rate that follows s then: 206

11 Snce we know the qut-rate functon (2), we can therefore determne noncompettve wages ( ) and the total unt labor costs n non-compettve sectors ( ) 9 : The, from (1) and (3), we get the compettve wage rate ( ): For gven postve values of parameters and, fgure 5 shows that non-compettve and compettve wages, as well as total unt labor costs n mperfect sectors (, and respectvely) and the wage dfferental, ( ), can be smply wrtten as functons of : FIGURE 5 Optmal wage rate and wage dfferental. 9. Note that we have, and, APPLIED GENERAL EQUILIBRIUM MODEL 207

12 The ntroducton of an mperfecton on the labor market alters the producton technology of non-compettve frms. Snce producers choose a wage rate hgher than that of full-employment, t mples an nvoluntary unemployment rate whch dscourages mgraton. Snce the chosen wage rate s effcent or optmal, frms are not wllng to decrease the wage rate n order to mprove the level of employment. The structure of the basc model s modfed as we have to take nto account the jont determnaton of unt labor costs n mperfectly compettve ndustres (4) and of the compettve wage rate (5). We also add the equatons (2) whch specfy the qut-rate functon (4). In our prevous non-compettve frm cost functon as well as our labor costs payment specfcaton (consumer s ncome), we now have to consder the unt labor cost. 4 Calbraton and Man Results 4.1. Data Base and Calbraton Procedure The chosen reference data year s 1985 because of avalablty constrants. The EEC set should therefore be understood as the EEC-10. The data set ncludes blateral trade flows, separate nput-ouput tables for domestc and mported nputs, fnal demands by type and sectoral orgn, output, and labor earnngs fgures, all collected from EUROSTAT [1985] and CHELEM-CEPII data base [1994]. The latter data base has been used only for the computaton of domestc share parameters of total mports. Therefore, the data set s based on statstcal sources that ensure ts consstency. Table 1 ndcates the adopted sectoral dsaggregaton of actvtes and the choce of reasonable values for the dfferentaton elastctes 10. Table 2 ndcates the European standardzed unemployment rates n The calbraton procedure used here s based upon the framework of MERCENIER [1995] 11. Ths procedure has the advantage of provdng a good consstency n the computaton of mperfect sector parameters: ndeed, the jont determnaton of the reference year prce system and scale economes (see tables 3 and 4) s establshed only wth data contaned n the socal accountng matrces (and not wth dfferent statstcal sources as t has been done n dfferent studes). Moreover, ths calbraton procedure does 10. The values for elastctes of substtuton s suppled from jont estmatons of MERCENIER [1995] and GASIOREK et al. [1992]; the number of symmetrc frms n non-compettve sectors ( s ) s nferred from Herfndahl ndces (EUROSTAT), Structure and Actvty of Industry, Data by sze of enterprses, [1984] and estmatons of GASIOREK [1992] for servces and constructon actvtes. 11. The calbraton procedure s presented n detal n PETIT [1996] and wll not be repeated here n order to save space. 208

13 TABLE 1 Sectoral Dsaggregaton and Elastctes of substtuton between products of dfferent frms wthn an ndustry ( ). Aggregate Producton Sectors Sectoral dsaggregaton Elastcty (Nace) Agrculture, food and prmary products 01, 06 and 36 C 2 Chemcal products 17 NC 5 Agrculture and ndustry machnery 21 NC 10 Offce machnery 23 NC 10 Electrcal goods 25 NC 6 Transport equpment 28 NC 7 Other manufacturng ndustres (textle, wood, paper, metallurgy, mnerals, etc.) 13, 15, 19, 42 and NC 5 Servces and constructon 53, 68 and 86 NC 18 TABLE 2 European Standardzed unemployment rates n GB DE FRA ITA RCEE Source: OCDE, Man Economc Indcators, TABLE 3 Calbrated Prce Spread wthn the EEC. COURNOT Chems. Agr & Offce Elec. Transp Other Serv. competton nd. mach. Mach. goods ndus. GB domestc prce a average export prce b DE domestc prce average export prce FRA domestc prce average export prce ITA domestc prce average export prce RCEE domestc prce average export prce a prce charged on domestc market; b average export prce to EEC. not exogenously mpose dentcal scale economes accross countres (see table 3), as s the case n GASIOREK, SMITH and VENABLES [1992]. Of course, there are alternatves that are just as consstent. For example, DE MELO and TARR (MIT Press, 1993) use econometrc estmates of scale economes as ther startng pont, before calbratng the Cournot-equvalent number of frms. Tables 3 and 4 report on the calbrated prce spread APPLIED GENERAL EQUILIBRIUM MODEL 209

14 TABLE 4 Calbrated elastcty of scale (ratos of average to margnal costs). Chems. Agr. & Offce Elec. Transp. Other Servces nd. mach. Mach. goods ndus. GB DE FRA ITA RCEE and the calbrated scale elastctes consstent wth the data base and the optmal prce dscrmnatng COURNOT-NASH behavor of non-compettve frms (see footnote 4). Despte the complexty of the calbraton procedure, the computed scale elastctes are wthn the expected range of magntude. Moreover, prce-dscrmnaton strateges seem to be less pronounced than those descrbed by MERCENIER (1982 data reference year). We can now focus on what s specfc n our calbraton procedure when ntroducng an mperfect labor market. In partcular, we have to compute the parameters of qut-rate functons as well as the ntal level of the unt labor costs n mperfectly compettve ndustres. The data base used n ths procedure s provded by the domestc accountng matrces or by data on unemployment rates n Europe n Due to the complexty of functonal forms, the computaton s performed wth a system of equatons. If s the labor value added n sector country gven by the domestc accountng matrces, then the labor force used n the compettve sector n country,, s, The calbraton of parameter values s performed wth the followng system of equatons, where s the unemployment rate n country (gven by the data base) and s the labor force used n all mperfect sectors n country. The computaton of ths non-lnear system gves the calbrated values of,, and. We can then easly determne the calbrated values 210

15 of parameter, and those of the ntal values of the qut rate and of the unt labor cost,, 4.2. The Results Effects of Market Integraton n the Case of a Perfect Labor Market The results of our basc scenaro wth flexble wages are presented n tables 5a and 5b. These results confrm that the basc theoretcal mechansms of the ntegraton process are ndeed at work. Ths process has a double effect on market structures: a pro-compettve phenomenon when the nternatonal degree of frm moblty s zero (short-term effect) and a ratonalzaton effect when ths degree s hgh (long-term effect). The pro-compettve effect mples a more elastc demand (fall n the frm s perceved elastcty of demand) that nvolves a domestc market prce drop (we can note a large drop of average sellng prces to EEC n spte of rsng exports prces). Output s stmulated, thereby mprovng domestc frms effcency (fall n scale elastctes). As mport competton stffens, domestc frms market power erodes, thereby reducng markups and profts and stmulatng output. The ntensty of ths effect depends on the degree of segmentaton and concentraton at the reference perod. We note that although welfare effects are n all cases unambguously postve for Europe, the gans reman qute modest (0.004% n Germany, 0.21% n Italy). In Europe, total output ncreases by 0.35% and 0.56% n the short and long run, respectvely. Also, real wages unambguously ncrease n all countres. The ratonalzaton effect does not seem to sgnfcantly affect the level of output, even though n some sectors/countres entres/exts may account up to 17%. However, welfare gans do not vary sgnfcantly. In fact, n the model, consumers value product dversty, and thus ratonalzaton acheved by ncreased ndustry concentraton has a cost n terms of welfare. An nterestng result s that ntegraton leads to many adjustments wthn EEC countres on an unequal bass. In partcular, the case of Germany (short-term case) and RCEE (long-term case) does not seem so good. We can see that, when the rest of the world s not taken nto account n the smulaton, European ntegraton favours many countres at the cost of others beng less well-off. APPLIED GENERAL EQUILIBRIUM MODEL 211

16 TABLE 5a Short-term effects of European Market Integraton: COURNOT competton, wthout entry/ext of frms, flexble wages. Aggregate ndcators GB DE FRA ITA RCEE (% changes) Welfare E Output Wage rate Cost-of-lvng ndex Terms of trade Employment Output CEE (% changes) 0.35 Employment CEE (% changes) Agr., Chems. Agr. & Offce Elec. Transp. Other Servces energy nd. mach. Mach. goods ndus. Output (% changes) GB DE E-3 FRA E-3 ITA RCEE Average sellng prce to EEC (% change) GB DE FRA ITA RCEE Profts (% of value added) GB DE FRA ITA RCEE Elastcty of scale (% change) GB E-4 DE 6.3 E E-3 FRA E-3 ITA E-3 RCEE E-3 It s nterestng to note the reversed tendency for Germany whch gans from ntegraton only n the long term (welfare, %; output, +1.58%). In fact, German producers hghly ncrease ther performances n specfc sectors (chemstry, + 22% and other manufacturng ndustres, + 2%) when ratonalzaton s at work (rsng number of frms). 212

17 TABLE 5b Long-term effects of European Market Integraton: COURNOT competton, wth entry/ext of frms, flexble wages. Aggregate ndcators GB DE FRA ITA RCEE (% changes) Welfare Output E-4 Wage rate Cost-of-lvng ndex Terms of trade Employment Output CEE (% changes) 0.56 Employment CEE (% changes) Agr., Chems. Agr. & Offce Elec. goods Transp. Other Servces energy nd. mach. Mach. ndus. Output (% changes) GB DE FRA ITA RCEE Average sellng prce to EEC (% change) GB DE FRA ITA RCEE Number of frms (% change) GB DE FRA ITA RCEE Elastcty of scale (% change) GB DE FRA ITA RCEE Effects of Market Integraton n the Case of Rgd Real Wages Tables 6a et 6b provde a detaled account of these smulatons whle table 9 reports on senstvty analyss. The results are very close to those provded by MERCENIER [1995]. For most European countres, productvty gans nduced by the elmnaton of prce-dscrmnaton strateges allow APPLIED GENERAL EQUILIBRIUM MODEL 213

18 TABLE 6a Short-term effects of European Market Integraton: COURNOT competton, wthout entry/ext of frms, rgd real wages. Aggregate ndcators GB DE FRA ITA RCEE (% changes) Welfare Output Wage rate Cost-of-lvng ndex Terms of trade Employment Output CEE (% changes) 0.68 Employment CEE (% changes) 0.64 TABLE 6b Long-term effects (wth entry/ext of frms, flexble wages and modfed labor supply). Aggregate ndcators GB DE FRA ITA RCEE (% changes) Welfare Output E Wage rate Cost-of-lvng ndex Terms of trade Employment Output CEE (% changes) 0.75 Employment CEE (% changes) 0.64 ncreasng job creatons. Productvty gans are not absorbed by wage ncreases but by job creaton. Ths s acheved by assumng European wages ndexed to the consumer prce ndex, so that workers that had a job before 1992 do not experence decreases n ther standard of lvng. In the short run, welfare and output gans are more than doubled for most European countres (1.34% for Great-Brtan). In the EEC as a whole, the ncrease n output s sgnfcant (0.68%) and ths s accomplshed wth an mprovement n the employment level (0.64%). In the long run, ndustry ratonalzaton ncreases welfare and output n Great Brtan (1.50% and 2.66%, respectvely) and RCEE (0.68% and 1.29%) whle other countres do not beneft from nternatonal frm moblty. In these countres, a large real wage cut s necessary to mantan employment at the level nherted from the short run. In any case, the welfare gans from 1992 reman far below those suggested by the Cechn report and are also less sgnfcant than those 214

19 provded by MERCENIER [1995] 12. Besdes, t appears that expected ntegraton effects are not homogenous n Europe: Germany seems to suffer from ntegraton n terms of welfare ( 0.15%) and employment ( 0.14%). However, n all other countres, the rgd real wages scenaro leads to an mprovement n the labor market (1.64% for GB and 1.06% for RCEE). One explanaton of these results s that we have only consdered the nternal ntegraton process n Europe. That s, the ncrease n European frm compettveness appears only wthn the economc regon consdered and has no effect on the external compettveness of frms outsde Europe. So, Germany, whch formerly benefted from a hgh degree of compettveness n Europe, s now facng ferce European competton. Its export performances drop thereby reducng ts output ( 0.30%). In the long run, we can also note that a real wage decrease s necessary to prevent Germany from worse labor market deteroraton. A frst concluson here s that when nternal structural ndustry changes are taken nto account, all member countres are not sure to gan from European ntegraton. Table 9 summarzes the senstvty analyss that has been performed wth respect to two mportant parameters: product dfferentaton and ndustry concentraton. We can see that the smulaton results seem to be qute robust. Effects of Market Integraton n the Case of Endogenous Imperfect Labor Market The results obtaned n the case of endogenous mperfect labor market (tables 7a and 7b) reveal a very dfferent vew of the consequences of ntegraton on employment n Europe. Indeed, smulatons show that the completon of the sngle European market may lead to global employment deteroraton. Moreover, the results n terms of welfare gve substance to the dea that some unon members could suffer from ntegraton. In the short-term smulaton, these effects are non homogeneous and may be very sgnfcant: output, employment and welfare changes are negatves n Germany ( 1.12%, 1.28% and 0.88%, respectvely). Also, the case of France s not very good snce pro-compettve phenomena mply a negatve welfare effect ( 0.27%) and job destructon ( 0.69%). We can also note that output ncreases (n Italy and RCEE) don t necessarly prevent domestc countres from ncreases n unemployment. Fnally, wthn the Communty, only the UK seems to really beneft from the elmnaton of prce-dscrmnaton strateges (average prce drop). All thngs consdered, n Europe, the short-term results suggest net labor market deteroraton ( 0.59%) and a very low output ncrease (0.02%). The ntroducton of an mperfecton based on endogenous behavor n the labor market may affect the usual ntutve story behnd the ntegraton process. Indeed, t t easy to magne how general-equlbrum effects 12. In MERCENIER [1995], the reducton n unemployment s estmated between 2.7 and 0.5% dependng on the country consdered (wth an EEC average of 1.5%) and welfare gans range between 2.1 and 0.4%. APPLIED GENERAL EQUILIBRIUM MODEL 215

20 TABLE 7a Short-term effects of European Market Integraton: COURNOT competton, wthout entry/ext of frms, mperfect labor market (turnover model). Aggregate ndcators GB DE FRA ITA RCEE (% changes) Welfare Output Effcency wage rate Compettve wage rate Cost-of-lvng ndex Terms of trade Employment Output CEE (% changes) 0.02 Employment CEE (% changes) 0.59 TABLE 7b Long-term effects (wth entry/ext of frms, turnover model). Aggregate ndcators GB DE FRA ITA RCEE (% changes) Welfare Output Effcency wage rate Compettve wage rate Cost-of-lvng ndex Terms of trade Employment Output CEE (% changes) 0.53 Employment CEE (% changes) 0.29 complex nteractons between ncome and substtuton effects on the demand sde and changes of steepness of the average-cost curve affected by movements n prmary factors prce on the offer sde can change the usual scenaro descrbed before. An endogenous mperfect specfcaton on the labor market that s based entrely upon mcroeconomc foundatons has the advantage of provdng a helpful tool to explan clearly the results of smulatons (see fgure 6). The turnover model s based upon frms optmzaton behavor. Ths modelng assumpton therefore helps explanng that the arbtrage between wage payments and turnover costs s an ncentve for the frm to lmt the varablty n the wage dfferental. The dea s smply that the greater the wage dfferental s, the greater the ncentve to mgrate wll be. So, when the compettve wage ncreases, non-compettve frms are wllng to rse ther wage rate. For example, n Italy, the compettve and the non-compettve wage ncreases are qute close (+ 0.73% and 0.65%). It mples that real wages ncrease snce, meanwhle, the consumer prce ndex decreases ( 0.27% n Italy). So, real wage ncreases affect frm 216

21 FIGURE 6 The Integraton Scenaro Explanaton (Turnover Model). TABLE 8 Welfare effects of European Market Integraton: Senstvty analyss wth flexble wages (%). Base case Hgher product Lower product Hgher ndustry Lower ndustry s s dfferentaton dfferentaton concentraton concentraton s s s s s s s s COURNOT competton wth fxed number of frms GB DE 4.1 E E E E-3 FRA ITA RCEE COURNOT competton wth varable number of frms GB DE FRA ITA RCEE E APPLIED GENERAL EQUILIBRIUM MODEL 217

22 TABLE 9 Welfare and Employment effects of European Market Integraton: Senstvty analyss wth rgd real wages (%). Base case Hgher product Lower product Hgher ndustry Lower ndustry s s dfferentaton dfferentaton concentraton concentraton s s s s s s s s COURNOT competton wth fxed number of frms: welfare gans (%) GB DE E FRA ITA RCEE COURNOT competton wth varable number of frms: welfare gans (%) GB DE FRA ITA RCEE Short-term effects: employment changes (%) GB DE E FRA ITA RCEE CEE compettveness and the result s a very low ncrease n output that drectly affects job creaton. Our labor market specfcaton has the advantage of provdng numercal experments that estmate the long-run consequences of ntegraton on employment. In partcular, these smulatons show clearly that ndustry ratonalzaton ncreases output n most countres and consequently reduces the negatve short-run effect of market ntegraton on labor market stuaton. For example, Italy really benefts from ths postve effect n all ts producton sectors. Its global output ncrease s very sgnfcant (2.32%) and allows ncreasng job creaton (1.75%). However, the EEC global output ncrease remans qute modest (0.53%) snce output levels have dropped n many countres. The European labor market stuaton s better than n the shortterm smulaton but ths mprovement seems to be relatvely low (0.29%). In spte of ths slght mprovement, Germany stll suffers from ntegraton n terms of welfare ( 0.53%), ouput ( 0.99%) and employment ( 0.50%). The labor market nprovement n domestc economes can be explaned by a real wage drop that mples a hgher output ncrease. The senstvty analyss (table 9) allows us to show agan that our estmates are globally robust wth respect to changes n parameters values. In any case, market ntegraton leads to substantal labor market deteroraton n the short-term smulaton and a slght recovery n employment n the long run. 218

23 TABLE 10 Welfare and Employment effects of European Market Integraton: Senstvty analyss wth mperfect labor market (turnover model). Base case Hgher product Lower product Hgher ndustry Lower ndustry s s dfferentaton dfferentaton concentraton concentraton s s s s s s s s COURNOT competton wth fxed number of frms: welfare gans (%) GB DE FRA ITA RCEE COURNOT competton wth fxed number of frms: employment changes (%) GB DE FRA ITA RCEE CEE COURNOT competton wth varable number of frms: welfare gans (%) GB DE FRA ITA RCEE COURNOT competton wth fxed number of frms: employment changes (%) GB DE FRA ITA RCEE CEE Concluson Prevous attempts to assess the welfare costs of prce dscrmnaton wthn the European Communty conclude that although unambguously postve for all countres, these costs are qute modest. We have shown here that they seem much lower than those estmated by the Cechn group and that they are less pronounced than those obtaned by MERCENIER [1995]. By contrast, one concluson of ths study s that, when an endogenous labor market structure s taken nto account, all member countres are not sure to gan from European ntegraton. In fact, we have shown that, n ths case, market ntegraton may lead to global European labor market deteroraton. Equally, welfare and employment effects may be negatve n most of European countres. The advantage of ntroducng an endogenous labor market mperfecton consstent wth walrasan mcroeconomc foundatons s that t ensures the relablty of the smulaton results. APPLIED GENERAL EQUILIBRIUM MODEL 219

24 APPENDIX A Formal Descrpton of the General Equlbrum Model Sectors of actvty are dentfed by ndces,, wth representng the set of all ndustres. Set s parttoned nto the subset of compettve, constant returns-to-scale sector,, and the subset of non-compettve, ncreasng returns-to-scale ndustres,, wth. Countres are dentfed by ndces,,. We keep track of the trade flows by followng the usual practce that dentfes the frst two ndces, wth, respectvely, the country and the ndustry supplyng the commodty and, when approprate, the next two wth the clent country and ndustry. Thus, a subscrpt ndcates a flow orgnatng n sector of country wth ndustry of country as recpent. 1. The Households Statc Decson Problem It s assumed that domestc fnal demand decsons n country are made by a sngle representatve agent. The domestc household values products of compettve ndustry from dfferent countres as mperfect substtutes (the Armngton assumpton), whle t treats as specfc each commodty produced by ndvdual frms operatng n the non-compettve ndustres. Ths s represented by a two level-utlty functon. The frst level combnes consumpton goods,, assumng constant expendture shares ( ). The second level determnes the optmal composton of the consumpton aggregates n terms of geographcal orgn for compettve ndustry or n terms of the ndvdual frm s product for the noncompettve sectors. Assumng symmetry between the non-compettve frms operatng wthn country s ndustry, the consumer s preferences are represented as follows, where are share parameters and are substtuton elastctes. Observe that when, denotes the sales of the whole ndustry of country, whereas when, t represents the sales of a sngle frm. 220

25 Fnal demands of country result from maxmsaton of (A1) subject to the followng budget constrant (A2): where denote prces. In ths formulaton, non-compettve frms have the possblty to prce dscrmnate between clent countres ( ). 2. The Behavor of Frms Compettve Frms In compettve ndustry, the representatve frm of country -sector, operates wth constant return-to-scale technologes, combnng captal, labor and ntermedate nputs. Materal nputs are ntroduced n the producton functon n a smlar way as consumpton goods are treated n the preferences of households: wth an Armngton specfcaton for goods produced by the compettve ndustry, wth product dfferentaton at frm level n the mperfectly compettve sectors. Input demands by producer result from mnmzaton of varable unt cost : such that: where and are the labor and captal unt cost, respectvely. In the model, the nternatonal rental rate of captal s chosen as numérare. Observe that although goods are ntroduced n consumers technologes wth the same degree of dfferentaton (substtuton elastctes are dentcal), prce responsveness wll not be the same as the are sector specfc. Cost mnmzaton mples margnal cost prcng ( ) and zero proft ( ) n the compettve sector. APPLIED GENERAL EQUILIBRIUM MODEL 221

26 Non-Compettve Industres Non-compettve ndustres have ncreasng returns to scale n producton. We model ths by assumng that n addton to varable costs assocated wth technologcal constrants smlar to (A3 ) ndvdual frms face fxed prmary factor costs. Ths ntroduces a wedge between total unt costs,, and margnal costs, : where,,, denote, respectvely, the ndvdual frm s output, fxed labor and fxed captal. Wth ntal segmentaton, the non-compettve frm explots the monopoly power t has on each ndvdual country market. So, the frm has the possblty to prce dscrmnate among segmented domestc markets. The objectve of the frm s to maxmze ts profts such that: To reach ts objectve, each producer s endowed wth the full knowledge of the preferences (A1 et A1 ) and technologes of ts clents (A3, A3, A3 ). Usng ths nformaton, he performs a partal equlbrum calculaton assumng that n each country, each ndvdual clent s currentprce expendture on the whole ndustry s unaffected by hs own strategc acton,, so that: and On the bass of the resultng perceved demand curves, the frm chooses country specfc proft maxmzng prces usng the LERNER formula: where s the frm s perceved elastcty of demand for market. We make the COURNOT assumpton of noncooperatve behavor wth sales 222

27 to each ndvdual market as the strategc varables (see Appendx B for the computaton of these elastctes): 3. The General Equlbrum A general equlbrum s a vector of prce (,, ) such that: supply equals demand on each market: where and represent fxed prmary factor endowments; profts equal zero n all compettve ndustres; n non-compettve sectors, the number of frms s fxed and possbly dffers from zero (short-term equlbrum wth fxed ndustry structure) or alternatvely, the number of frms s endogenous and profts are null (long-term equlbrum wth entry/ext); the perceved elastcty s evaluated at equlbrum prces and demands, so that, even though the frm may be slghtly mstaken on the true demand curve t faces, for the quanttes actually produced, t correctly perceves the prces that wll clear the market. APPLIED GENERAL EQUILIBRIUM MODEL 223

28 APPENDIX B 1. The Computaton of COURNOT Elastctes The computaton of these elastctes s made extremely complex because of the dstncton between fnal and ntermedate demands. However, MERCENIER [1995] has shown that t was possble to compute these elastctes nvertng the log-lnearzed aggregate demand system. To determne, t may be shown that for each,,, the followng system has to be solved: where varables and coeffcents, are cross-elastctes determned jontly wth, are cross-elastctes: 2. The Numercal Experment: the European Market Integraton Accordng to the modelng strategy we used untl now, the representaton of the market ntegraton experment conssts of assumng the elmnaton of all trade barrers so that ndvdual frms can no longer prce dscrmnate among ther natonal clents. At the European scale, t mples that one has to deal wth the EEC aggregate demand system rather than wth demands 224

29 from ndvdual countres. So, the experment of market ntegraton conssts n mposng the followng restrcton on the prcng rule: where s the frm s perceved elastcty of demand computed from the aggregated EEC market. When frms are assumed to play BERTRAND 13, the prce elastcty of demand on the ntegratred market s a weghted average of the prce elastctes on each ndvdual country market wthn the EEC: In the alternatve case where frms are assumed to play COURNOT, the perceved elastctes are computed from the log-lnearzed nverse EEC-aggregated demand system. The systems to be solved are those of Appendx B1, after substtuton of the EEC-aggregated elastctes and by and where approprate. References BROOKE, A., HENDRIK, D., MEERAUS A. (1988). GAM: A User s Gude, Scenctfc Press. BURNIAUX, J. M., WALBROECK, J. (1992). Prelmnary Results from Two Expermental Models of General Equlbrum wth Imperfect Competton, Journal of Polcy Modelng, 14, pp CARRUTH, A., OSWALD, A. J. (1987). On Unon Preferences and Labor Market Models: Insders and Outsders, The Economc Journal, vol. 97, june 87, pp CHELEM-CEPII (1994). Comptes Harmonsés sur les Échanges et l Économe Mondale : les nomenclatures détallées et les ndcateurs, CEPII. COMMISSION OF THE EUROPEAN ECONOMY (1988). The economcs of 1992, The European Economy, n 35. DIXIT, A. K., STIGLITZ, J. E. (1977). Monopolstc Competton and Optmum Product Dversty, Amercan Economc Revew, 67, pp ERLICH, S., GINSBURGH, V., VAN DER HEYDEN, L. (1987). Where Do Real Wage Polces Lead Belgum? A General Equlbrum Analyss, European Economc Revew, 31, pp EUROSTAT (1984). Structure et Actvté de l Industre, Données selon la talle des entreprse. EUROSTAT (1985). Comptes Natonaux SEC Tableaux entrées-sortes. GABSZEWICZ, J., VIAL, J. P. (1972). Olgopoly à la Cournot n a General Equlbrum Analyss, Journal of Economc Theory, 4, pp The results of the smulaton wth BERTRAND competton are not presented n the paper, see footnote 4. APPLIED GENERAL EQUILIBRIUM MODEL 225