Regional integration in the presence of monopolistic competition: Implications of enlarging the European Union

The European Union (EU) is perhaps the only regional integration scheme that has remained viable and grown successfully over the years. The proposed accession of the ten Central and East European Countries (CEECs) to the fifteen-nation EU (EU-15), to form a twenty-five nation customs union, has important ramifications for the various policies and institutions of the EU as well as for international trade and production. This study sought to (1) analyze the economy-wide and intersectoral effects of this proposed enlargement using an applied general equilibrium framework and (2) implement an alternative modeling framework incorporating imperfect competition--Chamberlinian monopolistic competition with firm-based endogenous product differentiation and economies of scale--to conduct this analysis. Agricultural policy, harmonization of protection, Uruguay Round agreement, EU budget, regional welfare, and trade creation/diversion were the various policy dimensions addressed. Analysis of regional economic integration is carried out under four different scenarios: integration in the presence of monopolistic competition and three alternative scenarios that sequentially removed varietal effects on demand, scale effects in production, and both effects. The integration simulations are preceded by a two-step preliminary simulation: the first step incorporated improved estimates of agricultural border protection and the second step created an integrated EU-15 and established the post-Uruguay Round tariff levels and other liberalization measures. A new approach to measure trade creation/diversion was developed. The CEECs are predicted to supply more farm and food products. On the other hand, more manufacturing, high technology goods, and services are produced by the current members of the EU. Production responses are heavily influenced by the harmonization of CEEC border measures with those of the EU. Increased global trade is stimulated by increases in non-agricultural imports and agricultural exports by the CEECs. Increased subsidy outlays due to expansion of CEEC agriculture are found to be offset by decreased outlays in the EU, resulting in a positive net transfer from the EU budget to the CEECs. Though trade diversion is found to diminish the efficiency in the CEECs, enlarging the European Union nevertheless results in global gains due to improved efficiency in the rest of the EU