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Investment Creation and Investment Diversion: Simulation Analysis of the Single Market Programme

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  • Baldwin, Richard
  • Forslid, Rikard
  • Haaland, Jan I.

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.

Suggested Citation

  • Baldwin, Richard & Forslid, Rikard & Haaland, Jan I., 1995. "Investment Creation and Investment Diversion: Simulation Analysis of the Single Market Programme," CEPR Discussion Papers 1308, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:1308
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    1. Gasiorek, Michael & Smith, Alasdair & Venables, Anthony J, 1992. "`1992': Trade and Welfare; A General Equilibrium Model," CEPR Discussion Papers 672, C.E.P.R. Discussion Papers.
    2. Baldwin, Richard E. & Venables, Anthony J., 1995. "Regional economic integration," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 31, pages 1597-1644, Elsevier.
    3. Haaland, J.I. & Wooton, I., 1991. "Market Integration, Competition, and Welfare," Papers 499, Stockholm - International Economic Studies.
    4. Smith, Alasdair & Venables, Anthony J., 1988. "Completing the internal market in the European Community : Some industry simulations," European Economic Review, Elsevier, vol. 32(7), pages 1501-1525, September.
    5. G. M. Grossman & K. Rogoff (ed.), 1995. "Handbook of International Economics," Handbook of International Economics, Elsevier, edition 1, volume 3, number 3.
    6. Haaland, Jan I. & Norman, Victor D, 1992. "Global Production Effects of European Integration," CEPR Discussion Papers 669, C.E.P.R. Discussion Papers.
    7. Baldwin,Richard & Haapararanta,Pertti & Kiander,Jaakko (ed.), 1995. "Expanding Membership of the European Union," Cambridge Books, Cambridge University Press, number 9780521481342, October.
    8. Baldwin, Richard E, 1992. "Measurable Dynamic Gains from Trade," Journal of Political Economy, University of Chicago Press, vol. 100(1), pages 162-174, February.
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    More about this item

    Keywords

    Investment Creation; Investment Diversion; Single Market Programme;
    All these keywords.

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F15 - International Economics - - Trade - - - Economic Integration
    • F17 - International Economics - - Trade - - - Trade Forecasting and Simulation
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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