Economic and Industrial Policy: Coping with the past or preparing for the future

1. Economic and Industrial Policy: Coping with the past or preparing for the future Joep Konings Bureau of Economic Policy Advisers European Commission & VIVES, Faculteit Economie & Bedrijfswetenschappen, KUL Industrial and Economic Policy

2. Disclaimer The views expressed are my own and do not necessarily reflect those of the European Commission Industrial and Economic Policy

3. Structure of the talk • I. Stylized facts • II. A framework: New Economic Geography • III. Implications for Economic/Industrial Policy Industrial and Economic Policy

4. I. Some Stylized Facts About the Changing Nature of Economic Activity Industrial and Economic Policy

5. Fact 1: Going home for the holidays# planes in the air before Thanksgiving in the US Industrial and Economic Policy

6. 1. Massive Decline in Transport Costs • Air transport (jet engine) • Sea transport (usage of containers, scale effects) • Communication costs (advances in telecommunications and internet): A 3 minute phone call from London to New York fell from $293 in 1931 to $1 in 2001 and to just a few cents today. Industrial and Economic Policy

7. Evolution of Air transport(source: Hummels, 2007) expressed in 2000 dollars, costs per ton-km fell from $3.87 in 1955 to $0.30 in 2004. Industrial and Economic Policy

8. Air transport price Indices computed on the basis of many international routes, both inbound and outbound (Hummels, 2007) Industrial and Economic Policy

9. Based on regression analysis, to take into account changing composition of products and destinations(Hummels, 2007) Industrial and Economic Policy

10. Same for Ocean transport Industrial and Economic Policy

11. Fact 2: Made in China… Industrial and Economic Policy

12. 2. Massive Decline in Import Tariffs Industrial and Economic Policy

13. Fact 3: Airbus is being produced all over Europe Industrial and Economic Policy

14. Fact 3. Globalization of the Supply Chain • The i-pod consists over 451 parts produced all over the world. Industrial and Economic Policy

15. Fact 4: Firms have turned global Industrial and Economic Policy

16. Fact 5: Concentration of Economic activity Industrial and Economic Policy

17. 5. More Spatial Concentration of Production • Due to the decline in transport and trade costs, large economies of scale can more easily be exploited, which was not possible when transport and trade costs were high. • As a result spatial concentration of production has intensified  Agglomoration economies, not only in Belgium, but everywhere Industrial and Economic Policy

18. Concentration of Economic activity in Poland Industrial and Economic Policy

19. II. A Framework to think about Economic Integration – New Economic Geography Industrial and Economic Policy

20. Agglomeration versus Dispersion forces • Agglomeration forces: • Firms locate in large markets to reduce trade costs • But by moving to a large market, they make the market larger (e.g. firms buy from eachother, workers spend their wages locally, etc.) • Cost advantages (locating near suppliers, suppliers move together, pushing prices of intermediates down, etc.) • Dispersion forces: • Office prices, land prices, wages increase due to density • Local competition increases, so you may want to move away from the competition Industrial and Economic Policy

21. Equilibrium and EU integration – simplified version • Assume only one dispersion force is local competition, then the strength of the dispersion force increases with the number of firms in a region. • Assume only one agglomoration force is to be close to the customers (market size), then the strength of this is independent of the number of firms • Effects of reduced trade costs? • Agglomoration has no effect (as just assumed it is market size) • Dispersion forces will fall as far away regions were protected from competition due to high trade costs. As trade costs fall, competition intensifies, so incentive to locate away from the large market drops. Industrial and Economic Policy

22. Graphical representation: the effects of reducing trade costs Strength of forces Dispersion force Agglomeration force Share of firms in big region E0 E1 Industrial and Economic Policy

23. III. Implications for Economic & Industrial Policy Industrial and Economic Policy

24. Consideration 1:EU Single Market imposes a legal framework on the Member States • Old type of industrial policy is no longer feasible as member states have delegated legal authority to comply with the rules governing the Single Market (aimed at lifting competitive distortions between MS) • Single Market: • Raised EU prosperity by 2.15% EU GDP per year • Created 2.75 million extra jobs between 1992-2006 • Intra-EU trade relative to GDP rose by 30% between 1995-2005 • Policy tool kit has to fit within the framework of state aid: • Non-discriminatory coverage • Long run viability • Temporary scope • Market pricing principles for fees • Short run interventions must be consistent with long run objectives  Risk of the current crisis: defending national interests at the expense of the SM Industrial and Economic Policy

25. Consideration 2:Interventions going against scale economies generated by agglomeration are likely ineffective • Policy targeted at equalizing economic activity are likely going to be less effective than policies aimed at equalizing economic welfare. The latter would include • Providing access to broadband and fast internet in the periphery • Stimulating mobility and education in the periphery • Investing in infrastructure in agglomorated regions reinforces cost linkages, which can stimulate the region and are likely to be effective interventions/ R&D clusters • Financial support to avoid relocation in the periphery is unlikely to prevent relocation Industrial and Economic Policy

26. Consideration 3: Casesupporting car assembly (Opel) • Arguments against: • Overcapacity • High costs of production • Non-green technology • Opportunity cost of support: what is the multiplier in alternative employment? • Arguments in favour • Clear agglomoration economies • They generate demand for parts (demand linkages) • Just-in-Time producton methods require suppliers to be nearby (cost linkages) • High-tech industry: technological spillovers Support linked to restructuring (long run viability) - Reskilling labour force takes time Industrial and Economic Policy

27. But: what is the alternative use of tax payers money, i.e. what are the benefits of putting the money in e.g. education? = difficult trade-off Industrial and Economic Policy

28. Conclusions • We have to change the way we think about economic and industrial policy, taking into account the new facts and insights obtained from the literature on new economic geography. • Check list for economic policy: • Is it consistent with the rules of the Single Market? • Does it have an impact on agglomoration/dispersion forces and if so, how? • Are there general policies helping equalization of economic welfare (e.g. through education) • What is the alternative use of government money in terms of reallocative efficiency gains? • Are the short run interventions compatible with long run objectives? Industrial and Economic Policy