Deeper, Wider and More Competitive? Monetary Integration, Eastern Enlargement and Competitiveness in the European Union

What determines a country’s ability to compete in international markets? What fosters the global competitiveness of its firms? And in the European context, have key elements of the EU strategy such as EMU and enlargement helped or hindered domestic firms’ competitiveness in local and global markets? We address these questions by calibrating and simulating a conceptual framework that merges the insights of traditional trade theory and new trade theory in a multi-country, multi-sector model with monopolistic competition and variable markups. The framework highlights the interactions between technological leadership, freeness of entry and market accessibility in determining the competitive environment of a country. Countries exhibiting technological advantage, freer entry and better accessibility to foreign firms develop a tougher competitive environment in which firms are more productive, operate at a larger scale and earn larger profits while quoting lower prices and lower markups. Our conceptual framework allows us to disentangle the effects of technology and freeness of entry from those of accessibility. On the one hand, by controlling for the impact of accessibility, we are able to construct an index of ‘revealed competitiveness’, which would drive the relative performance of countries in an ideal world in which all faced the same barriers to international transactions. On the other hand, by focusing on the role of accessibility while keeping ‘revealed competitiveness’ as given, we are able to evaluate the impacts of EMU and enlargement on the competitiveness of European firms. We find that EMU positively affects the competitiveness of firms located in participating economies. Enlargement has, instead, two contrasting effects. It improves the accessibility of EU members but it also increases substantially the relative importance of unproductive competitors from Eastern Europe. Overall, while EMU increases the toughness of competition in member countries, and through this channel generates lower average (delivered) costs, markups, prices and quantities, enlargement can be expected to have similar effects only after an increase in the ’revealed competitiveness’ of new members that is yet to come. JEL Classification: F12, R13