Economics of the EU - Essay Example

How asymmetric shocks create disequilibria in a monetary union and how labour market mobility cushion the impact of asymmetric shocks inside a currency area. The European Union area is heterogeneous with varying economic characteristics. The income per capita and the productive structures vary across the EU but with a certain degree of convergence (Copaciu, n.d, p. 58). These differences make the EU area vulnerable to asymmetric shocks that have different effects per region. These shocks are both common and country specific. For common shocks related to demand, the policy makers are faced with a wider gap between inflation and output. Shocks related to supply lead to a tradeoff between output stabilization and inflation. Country specific shocks are similar to asymmetric shocks across the European Monetary Union. Their nature is influenced by the economic structures from this area. Varied economic structures increase the probability of the asymmetric shocks. The costs executed by asymmetrical shocks under European monetary union are dependent on the relationship between nominal and real inertia within European countries (Egger et al., 2011, p.115). Various economists have compared seemingly high nominal inertia in the United States labour markets with comparatively little European nominal wage rigidity. As a result, these economists have made conclusions that costs within Europe that cause nominal inertia are not that high. This argument, however, seems to assume nominal rigidity in price context, which may be practically important like inertia in wages. Also, provided nominal rigidity exists, the cost it enacts in restoring actual equilibrium is greatly dependent on its relationship with real inertia in the economy (Bond et al., 2001, p.340). The framework of modern government has improved as a result of the economic exclusion of currency area, which has become essential. This is especially through the imposition of inconvertibility and exchange controls. Given the practical need for stabilization strategies in existing economies, an area required a different currency. If provided with macroeconomic shock, the financial costs of adjustment would be higher compared to those of changing the exchange rates, through changes in price levels and or factor mobility (Houssa, 2008, p.320). For separate currency areas, the case is apparently held well unless the effect of the shock varies with regions, that is, asymmetric. Suppose the impacts on all were similar, then the exchange rate of modifications required for adjustment would also be equal for all. In this case, separate currencies would be useless since they would have no purpose. Applying the theory of OCA, any two countries that usually experience symmetric shock, besides trading substantial section of their GDP, should fix their rates of exchange (Egger et al., 2011, p.118). Precisely, the taxonomy of shocks has four distinctions. These include differences between permanent and temporary shocks, those between sector specific and country specific, between financial and real shocks, and between policy-induced and exogenous shocks. Probably, the most significant distinction made is between shocks that are likely to possess only transitory effect. For instance, an expected decline in grouped demand as well as shocks shows a perpetual fall in competitive position. Shocks with transient effect can be rectified by counter-cyclical alterations in monetary and fiscal policy, and borrowing (Egger et al., 2011, p.119). Shocks involving a perpetual drop in competitive position can typically only be met by a fall in prices and comparative real incomes, through critical long-term restructuring or labour force migration. Distinguishing the two is vital since a mere confusion about them is worth leading to action that can worsen rather than improving the situation. More specifically, treating shock as if they were temporary by using a permanent or structural effect can only lead to cementing of the resultant loss of competition making required reform more difficult. The Theory of Optimum Currency Areas assumes two areas, for example, A and B with each manufacturing a good. A demand shift that is as a result of an adjustment in preferences for the goods made by A to those produced by B (i.e. an asymmetric shock), will reduce demand for A. This will lead to increasing unemployment and instigate a trade imbalance (Egger et al., 2011, p.117). Inflation will thus increase in B. In such a case, a common monetary policy cannot resolve the problems of the two economies simultaneously. A restrictive monetary policy (S up) can reduce inflation in B, while worsening the unemployment problem in A. An expansionary monetary policy (S down) would decrease unemployment in A, while worsening inflation in B as shown in fig 1. Figure 1: Shows shifts in demand for Country A and B Labour mobility across the EU is used as one of the mechanisms to counter the negative effects of these shocks. When using Labour mobility as an adjustment mechanism two facts are taken into consideration. The first one is that the labour mobility is lower in the EU than in the US or Canada due to the higher dispersion of unemployment rates. The second one is that the mobility within the EU countries is higher than the one across the EU nations (Copaciu, p.58). For example the interregional migration in Germany, France or UK is twice as much as it in Spain and Italy. Taking these factors into consideration shows that labour mobility has a low impact on the adjustment of asymmetric shocks. However, this is not true if the mobility is as a result of lack of incentives. The elastic ties of migration that reside in the economic outcomes such as unemployment rates and wages will help reduce the impacts of the asymmetric shocks. According to Copaciu (p.59), high wages will favour immigration hence reducing the unemployment rates. Countries with a higher labour mobility such as Germany can take a long time before the shock of unemployment is addressed by migration. In conclusion, according to endogenous paradigm, continuous integration may lead to uniform structures thereby reducing possibility and effects of asymmetric shocks. Although the Maastricht treaty creates integration through political incorporation, as at now the internal migration flows are not enough to cushion the impact of these shocks let alone sustaining a single market. The treaty was created to ensure common security and foreign policy, monetary and economic union, and community social dimension. Therefore, immigration from the old EU nations will help sustain labour supply and accommodate these shocks. Discuss the welfare effects of a preferential trade agreement (PTA). Are there any circumstances under which trade liberalisation is by all means welfare enhancing? Preferential trade agreements are treaties by which member countries discriminatorily eliminate trade barriers among their respective partners, with the safeguard against non-participants being upheld (Magee 2003, 50). The Free Trade Agreement (FTA) is a PTA in which every member country autonomously sets its external charge against non-members. A Customs Union (CU) on the other hand, is a PTA where member states establish a joint external tariff (CET). The European Free Trade Association (EFTA) and the NAFTA are examples of FTAs while The EU and MERCOSUR are examples of CUs. There are welfare effects of free trade agreements (FTAs) as well as customs unions (CUs). If the external tariff of a PTA is not extremely high, it benefits both its members and non-members. This can be achieved through practices like access to modern production technologies, administrative and managerial skills, market information to producers, and access to inputs. Under a pair of sovereign bilateral FTAs, the common welfare of every member is higher than that under free trade (Bond et al., 2001, p.344). Additionally, if an ordinary member is comparatively efficient then to the other countries, FTAs can realize higher global welfare from free trade. However, such an outcome is not ever possible under a CU. According to Neo-liberal economic reasoning, liberalization of commerce creates opportunities for companies or businesses to grow. Liberalization allows for better access to modern production technologies, administrative and managerial skills, market information to producers, and access to inputs (Bond et al., 2001, p.346). In addition, competition from imports brings about specialization, efficient resource allocation, and also relieves the economy of incompetent producers. This relieves the society of the burden of sustaining such individuals. Smaller economies also are likely to have higher trade shares in their GNP in comparison to large ones, with greater openness (Bond et al., 2001, p.348). As a result, their gains from such trade tend to be higher in comparison to those countries that restrict trade. Liberalization of trade also enhances consumer welfare and decreases poverty because consumers are given the chance to choose from a broad variety of cheaper and better quality imports (Bond et al., 2001, p.349). Therefore, trade liberalization enhances human development, sustainable economic development and growth, and social welfare. Figure 2: Shows the welfare gains by region due to trade liberalization (Bouët, 2008, p. 46) Do you expect to see a significant correlation between these two variables? What if you use the volatility of the unemployment rate instead of the long-term unemployment rate? Justify your answer. There is a significant relationship between employment protection and the long-term unemployment rate. As shown in the table 1 below, where there is larger employment rate, the long-term unemployment will be on a higher average, which reduces the rate of participation. However, the correlation varies with different countries since the effects of employment protection depend on the uniqueness of the institutional contexts and situations such as the duration and extent of unemployment subsidies. The Impacts of employment protection also vary with the compliance of different judicial practices and the economic policies in place. Table1: Shows the employment protection, Long-term unemployment and capitalism varieties (Chilosi, 2013, p.3) Employment protection in the country can be depicted by various factors within that country. For instance, an increase in the GDP is a clear indicator of employment protection. Increased investment as well as increase in the amount of goods exported demonstrates a sustainable growth and therefore employment protection (Egger et al., 2011, p.118). If a country experiences stable and lower rates of inflation, then it goes without saying that such a country has substantial employment protection. Bad business climate affects production. As a result, structural improvement of the business environment is a healthy step geared towards protecting the country’s employment. This is because climate is very critical in both the medium term and the longer term growth. Good climate is also ideal for the health of the employees and producers. Improving the structure of the business environment would also enhance female participation in the labour market, hence improved employment protection (Egger et al., 2011, p.119). This further ensures sustainability of healthy and inclusive growth. High rates of inflation signals long-term unemployment rates (Egger et al., 2011, p.119). An extensive deficit in the current account is also a clear indicator of long-term unemployment rate. Immense barriers to manufacturing growth are a clear sign of long-term unemployment since it hinders exportation and the growth of GDP. There is a significant correlation between the indicators of employment protection and long-term unemployment rates. Solutions to long time unemployment rates are virtually the indicators of employment protection (Egger et al., 2011, p.120). Taxation, employment protection and unemployment protection reduce the volatility of unemployment rates. This is because of the nature of union bargaining, which has significant implications on the dynamics of unemployment. Figure 3: Shows the percentage of working age population for the OECD countries (OECD library) The welfare effects when a country such as Switzerland chooses to restrict its labour market to the European Union There is an increased supply of labour since Switzerland has low employment rate and a highly skilled labour force. If there is an increase in the supply of labour, there may be a need to exert a downward pressure on jobs and wages without offsetting the changes in demand (Demertzis, Hallett & Rummel, 2000, p.650). In the case where the skill composition of citizens is intended towards the highly skilled with a low employment rate labour force, several effects can be felt. This is true if such a country restricts its job market to the European Union. In a country that does not regulate its labour market the changes in the diversity of skills among the immigrants over time can account for the convergence in the rate of unemployment. However, averagely, given their qualifications, the immigrants remain more likely to be unemployed (Demertzis, Hallett & Rummel, 2000, p.651). New immigrants for instance, are not able to claim state benefits except if they work or pay adequate contribution while working. Due to the high skilled labour force in Switzerland it is expected that pressure inflicted on jobs or wages would be among these skilled workers in the country, unless immigrants search for jobs that are not proportionate to their skills. This can also be expected if it is difficult to transfer some specific acquired skills from one state to another. However, if there is an increase in the demand for labour, there would be no impact of immigration on employment and wages (Demertzis, Hallett & Rummel, 2000, p.654). This implies that unlike an open economy that can adjust by other means far from wages, a restricted economy cannot be adjusted by such means. If the demand for labour exceeds its supply due to the restrictions put in place, then the job availability in this receiving country and the impact of immigration will totally be different from the ones in the country that is readily at full employment (Demertzis, Hallett & Rummel, 2000, p.657). Representing the wage labour diagram for a country like Switzerland, demonstrating the effects of restricting the country’s job market to the European Union, the employment wage curve for such a country will be upward sloping. This is because, with an increase in the salaries, fewer workers enter the job market as depicted in the diagram below. The degree to which a rise in the prevalent wage causes an expansion in the supply of labour is dependent on the of supply elasticity. Figure 4: Relationship between wage rate and employment The less skilled workers can be considered as closer substitutes for immigrants compared to those who are highly skilled (Demertzis, Hallett & Rummel, 2000, p.662). This implies that any pressure arising from increased job competition is likely to be encountered among the less skilled workers. The European Union migrants, therefore, can be said to impact on the labour market performance of Switzerland if the restrictions are not put in place. Would your analysis differ for Scotland? If it were possible would you advise the Scottish government to restrict immigration of labour from England or other parts of the European Union? The analysis is similar for the case of Scotland since both nations are in the same regional block. This is because the trade union movement is not fragmented or subjected to the completion of extra trade unions with zero view ideologies. Although during strong economic growth periods, migration of labour serves an important purpose of filling the job market gaps, the hostile consequences of labour immigration have also been averagely materialized (Demertzis, Hallett & Rummel, 2000, p.659). It is hard to find sufficient evidence for the displacement of the Scottish workers or lower wages, averagely. However, these are some effects that would come with immigration of labour. For instance, workers who are less skilled may have encountered greater downward pressure on wages as well as greater job competition compared to others. It is also important to note how regional and capital shifts in demand react to immigration in the longer run. As opponents of labour mitigation state, this practice can have probable costs of an increasing inflow of new workers (Demertzis, Hallett & Rummel, 2000, p.668). For instance, it can depress the actual wages of domestic workers. For example, new worker inflow leads to increased low skilled worker supply. This in turn drives down the local little-skilled employee’s equilibrium wage. Also, it brings about doubt on productivity effect. Labour immigration increases pressure on the state’s welfare. The taxpayer may finally be compelled to be accountable for the increased government spending required to expand the infrastructure of the economy. There is also the risk of more unemployment should the skill profile of migrants fail to meet the demands of the growing industries in the economy (Demertzis, Hallett & Rummel, 2000, p.670). Lastly, inflow of immigrants in the country can increase the demand for resources, therefore, increasing the cost of living. Based on the above-presented arguments, it would be better if Scotland restricts immigration of labour from England and even from other parts of European Union so as to allow only skilled labour. The highly educated and skilled labour complements the less skilled natives. Figure 5: Shows the effects of Immigration on wages of the less educated native employees from 1990-2000 (http://www.voxeu.org/article/labour-market-effects-migration-oecd-countries) Figure 6: Shows the skills gaps expressed as a proportion of labourers by their profession (What the evidence tells about the next steps for Scotlands economic strategy, 2009, p.21) Skill gap refers to the unavailability of skilled labour, that is, employees with a certain level of skill. Figure 7 and 8: Show the ratios of labour supply and labour demand for Scotland as at September 2014. (https://www.nomisweb.co.uk/reports/lmp/gor/2013265931/report.aspx) The labour supply is higher than the labour demand; therefore, it would be better if Scotland restricts immigration. References Bond, Eric W, Syropoulos, Constantinos, & Winters, L, A 2001. ‘Deepening of Regional Integration and Multilateral Trade Agreements’,Journal of International Economics, vol. 53, no. 1, pp. 335-362. Bouët, A 2008, The expected benefits of trade liberalization for world income and development: Opening the Black box of global trade modelling, Food Policy Review. Available from: Chilosi, A 2013, Long-term unemployment in the varieties of capitalism, University of Pisa. Available from: Copaciu, M , Asymmetric shocks across european monetary union: Can labour mobility act as an adjustment mechanism?Central European University. Available from: Demertzis, M, Hallett, A H, & Rummel, O 2000,‘Is the European Union a natural currency area, or is it held together by policy makers’, Weltwirtschaftliches Archiv, vol. 136, no. 4, pp. 657-679. Egger, P, Larch, M, Staub, K E, & Winkelmann, R 2011,‘The trade effects of endogenous preferential trade agreements’,American Economic Journal: Economic Policy, vol. 1, no. 1, pp. 113-143. Houssa, R 2008,‘Monetary union in West Africa and asymmetric shocks: A dynamic structural factor model approach’,Journal of Development Economics, vol. 85, no. 1, pp. 319-347. Magee, C S 2003,‘Endogenous preferential trade agreements: An empirical analysis. Contributions in Economic Analysis & Policy, vol. 2, pp. 45-63. Read More