Lecture 8 - Integration and Growth

Introduction

EU customs union had significant trade effects, but one-off impact on welfare/SoL seems small (cf. Gasiorek et. al.)
Lecture 4 - The trade and specialisation effects of the EU Customs Union

Growth Theory

The GDP measures output of all goods and services in the eonomy
Economic growth involves an increase in

In Europe growth in GDP/per capita was c.2% per annum over the last century

The source of the growth was derived from improvements in technology. Aided by the Solow model

Steady state limit to growth

Recall in Lecture 7 - The Economics of a Common Market for Labour how increased amount of labour with fixed capital () lead to diminishing marginal productivity of labour

Hence, immigration lead to lower and lower

Similarly if labour force is fixed, adding more increases output at a declining rate (diminishing returns to )

depreciates and has to replaced by investment
The bigger the stock, the more depreciation, in direct proportion

Some key equations
Symbols:
- Capital per worker
Standard Solow notation: total capital K divided by labour L, i.e.
- Savings rate per worker
Equal to investment in a closed economy. in the standard Solow model, where s is the saving rate.
- Investment per worker
New capital created through saving.
- Depreciation rate
Amount of capital that wears out each period. captures how much of the capital stock depreciates.
- Depreciation Rate/Productivity Coefficient
If the model uses “” to represent depreciation, then is the depreciation rate. If instead is called a “productivity coefficient”, it scales how productive capital is. Given your notes, it likely denotes the fraction of capital lost to depreciation.
- Change in capital stock per worker
Represents net investment or capital accumulation:

As the stock of increases:

A larger portion of savings is used to replace depreciated capital.
Therefore, less savings remain available to expand the total capital stock.
Eventually, all savings are used for replacement, meaning there is no further increase in — this is the steady state.

A rising standard of living ultimately requires improvements in technology and know-how, not merely an increase in capital investment.

Solow Growth Model

(c.f. Lecture 7-8 - The Era of Sustained Economic Growth and Lecture 9-10 - Human capital and Growth empirics)

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Solow Growth Model I (Slide 6)

The model assumes a fixed labour force and focuses on how output changes with capital accumulation.
The output curve (Y) rises with capital, but at a diminishing rate, reflecting diminishing marginal returns to capital.
The savings curve represents a constant proportion of output:
where () is the savings rate.
As capital stock increases, total output rises, but each additional unit of capital produces less additional output.

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Solow Growth Model II (Slide 7)

Introduces depreciation , shown as a linear line since a fixed proportion of capital wears out each period.
The savings curve maintains a diminishing slope because it depends on output, which increases at a decreasing rate.
The steady state (SS1) occurs where savings (investment) equals depreciation.
At this point:

There is no net increase in capital.

Solow Growth Model III (Slide 8)

Before reaching the steady state, savings exceed depreciation, leading to net investment and capital accumulation.
The shaded area below the savings curve and above the depreciation line represents the addition to productive capacity.
The portion along the depreciation line represents replacement of worn-out capital.
As () rises, the gap between savings and depreciation narrows, slowing accumulation.

Solow Growth Model: Steady State (Slide 9)

The economy converges to a steady state at where:

and capital accumulation ceases.
At , output (Y), savings, and depreciation remain constant at their steady-state levels .
Further growth in living standards must come from technological progress, not from capital accumulation alone.

How does this relate to regional integration?

Two arguments

Baldwin medium term growth bonus

Integration increases trade one-off gain
Baldwin argues for further effect
The increase in output (), increases incomes and therefore savings () assuming at a fixed percentage
1. Increases investment
2. Raises SS level of GDP
Over periods of years the economy will adjust
So impact is greater than comparative static analysis suggests

Solow Growth Model — Medium Term Growth Bonus (Slide 11)

The diagram illustrates how economic integration can temporarily raise growth through an increase in productivity and savings.

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1. Initial Steady State

The economy begins at steady state SS₁, where:

and the steady-state capital stock is:

At this point, output and income are constant at:

2. Integration Effect on Productivity

Integration (e.g. trade liberalisation or capital mobility) shifts the production function upward due to higher productivity.
This creates an output effect at the same level of capital, increasing output from to .
Higher productivity raises income and therefore increases total savings.

3. Shift in the Savings Curve

The rise in income increases savings from to , shifting the savings curve upward.
At the same time, the depreciation line remains unchanged since the depreciation rate is constant.

4. Transition to a New Steady State

With savings now exceeding depreciation at , capital accumulation resumes.
Investment continues until a new equilibrium is reached at SS₂, where:

resulting in a higher steady-state level of capital and output

5. Interpretation

The medium-term growth bonus (MTGB) arises because:

Integration initially boosts productivity and output at the existing capital stock.
The resulting increase in savings drives further capital accumulation.
The economy converges to a new, higher steady state with greater income and output levels.

This effect is transitory; long-run growth still depends on technological progress, not capital accumulation alone.