Baldinger 2005 Growth Effects of Economic Integration

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Growth Effects of Economic Integration:

Evidence from the EU Member States

Harald Badinger

University of Economics and Business Administration, Vienna

Abstract: After compiling an index of economic integration that accounts for

global (GATT) as well as regional (European) integration of the EU member stateswe test for permanent and temporary growth effects in a growth accounting frame-work, using a panel of fifteen EU member states over the period 19502000. Whilethe hypothesis of permanent growth effects is rejected, the resultsthough notcompletely robust to controlling for time-specific effectssuggest sizeable level ef-fects: GDP per capita of the EU would be approximately one-fifth lower today ifno integration had taken place since 1950. JEL no. C33, F15, F43, O52Keywords:Economic growth; economic integration; European Union; panel data

1 Introduction

The second half of the twentieth century was characterized by unprece-dented progress in both global and regional economic integration. Thedevelopment of the European Unions (EU) external and internal economicrelationships mirrors these two overlapping processes. Global economic in-tegration, here mainly considered as trade liberalization in the frameworkof the General Agreement on Tariffs and Trade (GATT), led to a reduction in

the EUs (formerly the European Communitys (EC)) harmonized externaltariff from some 17 per cent in 1968 down to 3.6 per cent in 2000. Withinthe same time, the EC expanded from six members originally to 15 mem-bers. These member states not only completely liberalized their intra-traderelations, but also established a Single Market, introduced a single currency,installed common institutions (European Council, European Commission,European Court of Justice) with considerable supranational competenciesand adopted common or co-ordinated policies in several important areas

Remark: I wish to thank Fritz Breuss for a number of helpful comments on an earlierdraft This paper has also benefited much from the comments of an anonymous referee


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Badinger: Growth Effects of Economic Integration 51

(such as monetary policy, external trade, agriculture, competition, energy

etc.)A question of great interest not only from an academic point of view but

also from an economic policy and public perspective relates to the conse-quences of this process for economic growth and thus human welfare. Froma theoretical point of view, both negative and positive effects of integrationare conceivable: Countries that are integrated into the world economy in-teract with one another in several dimensions. They trade goods on worldproduct markets, borrow and lend on world capital markets, and exchangeinformation through market and nonmarket channels. Many of these globalinteractions generate forces that accelerate growth in every country. But sev-eral suggest reasons why international integration might impede growth(Grossman and Helpman 1997: 336). Moreover, economic theory is stillsplit on whether the integration-induced effects on the growth rate are onlytemporary (neoclassical growth theory, endogenous growth theory withoutscale effects) or permanent (endogenous growth theory with scale effects).Thus, more empirical work on this issue seems warranted, given its obviouspolicy relevance. Being the most far-reaching integration project in history,

the EU offers an example par excellence to test different hypotheses concern-ing the effects of economic integration on growth. Surprisingly, however,and in contrast to the large literature on trade, openness and growth (seeLewer and Van den Berg (2003) for a recent survey), there are only few stud-ies on this issue and with conflicting results. Landau (1995) finds no effectof EC membership on growth at all. In contrast, the results of Henreksonet al. (1997) point to apermanent effecton the growth rate, ranging from0.6 to 1.3 per cent per annum. More recently, the hypothesis of permanenteffects on the growth rate has been rejected again by Vanhoudt (1999).Obviously, a proper measurement of economic integration is a prerequisitefor the estimation of its effects; the variables used in previous studies on theeffects of European integration (such as dummies for membership in theEC and/or EFTA, length of membership, trade shares or market expansionas a result of the EC enlargements) may only be poorly correlated withthe actual liberalization process, which may in part explain the conflictingresults.

In this paper wecompile a new measure of the EU-15s economic integra-

tion, which captures both GATT liberalization and European integration.It considers all the relevant steps of European integration (EC, EFTA, trade


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52 Review of World Economics 2005, Vol. 141 (1)

this integration variable we go on to test for permanent and temporary

growth effects of integration in a cross-country growth accounting frame-work, using a panel of the 15 EU member states over the period 19502000.While the hypothesis of permanent growth effects of economic integrationis strongly rejected, we find sizeable level effects of integration. GDP percapita of the EU-15 would be approximately one-fifth lower today if nointegration had taken place since 1950.

The remainder of the paper is organized as follows: Section 2 discussesthe theoretical background to the empirical model used in the estimations.Section 3 presents a new measure of economic integration for the EU mem-ber states. Section 4 describes the data used in the estimation of the empiricalmodels in Section 5. Section 6 summarizes the results and concludes.

2 Theoretical Background and Empirical Model

In order to provide a minimum formal framework for our discussion,we consider a simple CobbDouglas production function with constant

returns to scale Y=AK

L

, where Yis output,A is technology,Kis capital,Lis labour, and and = 1 denote the respective output elasticities.Dividing by labour and taking log differences we have

lnyt= lnAt+ ln kt, (1)

wherey= Y/L andk = K/L. From this common formulation it is easilyrecognized that integration may affect growth via one of two (supply-side)channels: technology,A, and physical capital,K. Accordingly, the literaturedistinguishes between technology-ledandinvestment-ledgrowth effects of

economic integration (Baldwin and Seghezza 1996).1

2.1 Integration-Induced Technology-Led Growth

The hypothesis that economic integration improves an economys overallefficiency is at least as old as Adam Smiths famous dictum that the divisionof labour is limited by the extent of the market (Smith 1789, Book I, Chap-ter III). More opportunities to exploit economies of scale in an increased

1 In a more general specification the production function would also include human capi-tal Correspondingly there is also a skills-led growth hypothesis Since we obtained no sig-


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market are also stressed by Balassa (1961) as a propelling force of eco-

nomic integration. Baldwin (1989, 1993) emphasizes the role of enhancedfactor mobility, lower trade costs and more competition in promoting aneconomys efficiency. A further rationale for the technology-led growth hy-pothesis is provided by Coe and Helpman (1995), who find that a countrystotal factor productivity is not only determined by its own R&D capitalstock, but also by that of its trade partners. By easing technology spill-oversfrom abroad, integration enhances a countrys opportunities to improve itsefficiency by participating in other countries technological progress.

Denoting the level of integration at timetwithINTt, thetechnology-ledgrowth hypothesiscan be written in its most simple form as

lnAt= A0 + A1INTt, (1a)

where A0 is an exogenous component of technological progress. Equa-tion (1a) as it stands postulates only temporary growth, i.e. level effectsof economic integration, as usually assumed in neoclassical growth theory,where the steady-state growth rate is determined only by an exogenous rateof technological progress. Alternatively, a permanent effect on the growthrate is conceivable, which can be formalized by replacing the progress inintegration INTtin (1a) with its levelINTt, yielding

lnAt= P

A0 +P

A1INTt. (1a)

The hypothesis of permanent growth effects of integration emerges from en-dogenous growth theory with scale effects. Romer (1990) is a representativemodel, whichmainly as a result of assuming constant returns to the stockof knowledgeimplies that larger countries grow faster. Simply speaking,

in this framework integration can be viewed as an increase in the size ofthe economy, leading to a higher steady-state growth rate.2 Endogenousgrowth models with scale effects were strongly criticized in an influentialpaper by Jones (1995); a number of endogenous growth models withoutscale effects have been developed since then (e.g. Young 1998). Predictingonly level effects of integration, their conclusions with respect to the growtheffects of integration can be reconciled with neoclassical growth theory. Inour empirical analysis, both competing hypotheses represented by (1a) and

(1a) will be considered.


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2.2 Integration-Induced Investment-Led Growth

In the light of the empirical evidence, some authors regard a two-chainlink between trade and growth through investment as more relevant thantrade-induced efficiency increases (Levine and Renelt 1992). Some intuitivereasoning on this investment-led growth hypothesis can already be foundin Balassa (1961), who stresses the role of integration in creating a morefavourable environment for entrepreneurial activities, reducing the riskpremium for investments (less uncertainty), and lowering the cost of capitalas a result of more efficient financial markets. Again, in the neoclassical

framework the postulated effects on the growth rate are only temporary. Inits simplest form, theinvestment-led growth hypothesiscan be written as

ln kt= k0 + k1INTt. (1b)

The corresponding hypothesis of permanent investment-led growth effectsis provided by the class ofAKmodels, a branch of endogenous growththeory with a constant-returns-to-capital production functionY=AK.3

However,AKmodels have been criticized for their knife-edge character

and empirically by Jones (1995: 509), who concludes that the AK modelsdo not provide a good description of the driving forces behind growthin developed countries. Once more, the existing evidence suggests that theinvestment-led growth effects of integration, if any, are only level effects, butthe hypothesis of permanent effects can again be easily tested by replacingINTwithINTin (1b).

2.3 Overall Growth Effect of Economic Integration

With a view to the empirical analysis one could debate the need to dividegrowth between the accumulation of inputs and improvements in technol-ogy. For some questions of interest, this division is unnecessary, and shouldprobably be avoided. ... if the focus is a policy variable like inflation or the-budget positionor, as in our case, economic integrationit will oftenbe preferable to omit factor accumulation altogether and concentrate on theoverall growth effect of policy measures (Temple 1999: 150). This overall

3 Ignoring depreciation, an investment ratio of s implies that the capital stock and out-put grow at a rate of sA If one is willing to assume that integration causes a permanent


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growth effect of integration is obtained by substituting (1a) and (1b) into

(1), yielding

lnyt= 0 + 1INTt, (2)

where0 = A0 + k0, and1 = A1 + k1. The hypothesis of permanentgrowth effects can be tested using

lnyt= P0 +

P1INTt. (3)

In our empirical analysis we will depart from these models without factoraccumulation. Additionally, we will test (1a) and (1b) directly, as well asa quasi-reduced form of (1) and (1b) in order to assess the relative im-portance of the technology and the investment channel. Since we are notconcerned with the issue of convergence here, we regard this cross-countrygrowth accounting approach, which was (re-)introduced by Benhabib andSpiegel (1994) as an alternative to the convergence specification with theinitial level of income, as the more appropriate specification for our questionof interest.

3 On the Measurement of Economic Integration

Obviously, a proper measurement of economic integration is a prerequisitefor estimating its effects. Nevertheless, the choice of proper integration vari-ables has hardly attracted attention in the literature. Ben-David (2001), ina response to Slaughter (2001) who questions the convergence-stimulatingrole of trade obtained by Ben-David (1993) shows that a failure to distin-guish formal from actual periods of liberalization may lead to potentiallymisleading results. This criticism applies equally to previous studies on thegrowth effects of European integration which usecrude integration variablesas zero-one dummies for membership in EC/EFTA, length of membershipsin the EC/EFTA (Landau 1995; Henrekson et al. 1997) or market expansiondue to the EC enlargements in terms of relative increases in the ECs popula-tion or GDP (Vanhoudt 1999). Obviously, such simple measures can hardlycapture the EU-15s complex process of post-war economic integration,

which is summarized in Table 1. First, integration is a continuous process,not characterized by discrete jumps as reflected in zero-one dummies. The


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Table 1: Major Steps of EU Member States Post-War Economic Integration

European integration GATT liberalization

1944: Benelux Customs Union (BE, LU, NL)a) elimination of tariffs between BE, LU, NL,b) harmonization of external tariff (1950: 9%),(assumed) implementation: 19451950.

1950: Individual external tariffs (%)AT (20), BE (9), DE (16), DK (5),ESa (24), FI (13.5), FR (19), GRa (24),IEa (17), IT (24), NL (9), PTa (24),SE (6), UK (17).

1958: EC-6 (BE, DE, IT, NL, LU, FR): Customs Uniona) elimination of intra-EC-6 tariffs, b) harmoniza-tion of external tariff (1968: 16.8%), implementation:19581968.

1960: EFTA-7 (AT, CH, DK, NO, PT, SE, UK)elimination of intra-EFTA-7 tariffs, (1961: free tradeagreement FI-EFTA), implementation: 19601967.

19641967: Kennedy-Roundaverage (relative) tariff reductions: 47%,assumed implementation: 19681972.

1973: First EC enlargement (DK, IE, UK) EC-9a) elimination of tariffs between DK, IE, UK andEC-6, b) harmonization of external tariff, implemen-tation: 19731978.

1973: Free trade agreements between EFTA-6 and EC-9elimination of tariffs between EFTA-6 members (AT,CH, IS, NO, PT, SE) + FI and EC-9, implementation:19731978.

19731979: Tokyo-Roundaverage (relative) tariff reductions: 30%,assumed implementation: 19801985.

1981: Second EC enlargement (GR) EC-10a) harmonization of external tarif, b) elimination oftariffs between GR and EC-9, implementation: 19811985.

1986: Third EC enlargement (ES, PT) EC-12a) harmonization of external tarif, b) elimination oftariffs between ES and EC-10, implementation: 19861995.

19861993: Uruguay-Roundaverage (relative) tariff reductions: 40%,assumed implementation: 19941999.

1993: Single market (EU-12)4 freedoms + flanking measures (common policies),instantaneous implementation assumed.

1994: European Economic Area (EEA)partial implementation of four freedoms betweenEU-12 and EFTA-7 except CH (AT, FI, IS, LI, NO,SE), instantaneous implementation assumed.

1995: Fourth EC enlargement (AT, FI, SE) EU-15a) harmonization of external tariff, b) participationin Common Market, instantaneous implementationassumed.

Note:Country index: Austria (AT), Belgium (BE), Denmark (DK), (West)-Germany (DE), Finland(FI), France (FR), Greece (GR), Ireland (IE), Italy (IT), Netherlands (NL), Portugal (PT), Spain (ES),

Sweden (SE), United Kingdom (UK), Luxembourg (LU). Monetary integration (1978: EMS, 1999:EMU) is not considered here. Data on tariff levels, size and timing of tariff reductions and tariff har-monization taken from Breuss (1983), El-Agraa (2001), and WTO (1995).a i di i i l h l d di h l i i i f


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period of five years to implement the customs union after their accession to

the EC in 1973. Second, identifying the progress in the EU-15s economicintegration with EC enlargements is partly misleading, in particular for theformer EFTA countries (but also FI), which had already completely liber-alized their trade relationships with the EC in the free-trade agreements inthe 1970s, not only with their EC (EU) accession, which then only requiredthe harmonizing of the external tariff, andsince 1993the adoption ofthe Single Market Programme with its four freedoms. Finally, the EU-15seconomic post-war integration was not only driven by regional Europeanintegration, but also by global economic integration, viewed here as tradeliberalization in the framework of the General Agreement on Tariffs andTrade (GATT) (see Table 1, right column).

In this paper we propose a new measure of the EU-15s economic in-tegration, which takes both GATT liberalization and European integrationinto account. It captures all the relevant steps of European integration (EC,EFTA, trade agreements between EC and EFTA, Single Market, EuropeanEconomic Area (EEA)) and considers their continuous implementation.The integration index for countryi is based on the following measure of

protectionism

PROTi,t= Ti,t+ TCi,t=J

j=1

wij,t(tij,t+ tcij,t), (4)

which is essentially a weighted sum of tariffs,tij, and trade costs,tcij, wherethe weights,wij, correspond to the share of countryis trade with countryj(imports plus exports) in the total trade of countryi. If the trade regimes ofthe countries are symmetric, thenT

ialso measures (at least approximately)

other countries protectionism against countryiandTCialso measures theaverage trade costs of an enterprise of countryi. At least changes in theprotectionism of each country should be highly correlated if liberalizationhas been conducted on the principle of reciprocity. In this case the index(PROT)although first a measure of countryis protectionism against therest of the worldcan also be interpreted as a more general measure ofintegration of the according country with the world economy.

Let us first consider the calculation of the weighted tariffTiin (4). Un-

fortunately, there are no time series data for the tariffs of EU countries.We have, however, information on the initial tariffs in 1950 for most of the


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General-Most-Favoured-Nation Treatment (Article I of GATT) this gen-

eral external tariff applies (should apply) to 100 per cent of trade, unlessthere are special agreements of regional integration (admissible under Art-icle XXIV of GATT). Starting from the initial level in 1950, the developmentof the EU-15s external tariffs was then shaped by the GATT tariff reductions(see Table 1, right column) and the requirement to adopt the ECs externaltariff after joining the EC. The ECs external tariff, in turn, was harmonizedby the establishment of the customs union between the original six ECmembers until 1968, and later on reduced after each of the GATT rounds.Figure 1 shows the corresponding development of the countries externaltariffs, ending up with a harmonized external tariff for all EU member statesof 3.6 per cent in 2000.

Figure 1: External Tariff af EU-15 Member States, 19502000

The process of regional European integration went beyond GATT lib-eralization, leading to a complete elimination of intra-EU and intra-EFTA

tariffs, as well as of tariffs between EU and EFTA countries (see Table 1, leftcolumn). The calculation of the measure PROTi for the individual coun-


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countries have been eliminated. The procedure cannot be outlined for each

country in detail here; the essential ingredients, however, are summarizedin Table 1.

In order to quantify the effect of the Single Market we use a measure ofweighted trade costs,TCi. The variable tcijis not an overall measure of tradecosts between countryiandj, but is meant to represent only that extent oftrade costs between countryiandjwhich has been eliminated by the SingleMarket. Following Smith and Venables (1988), we assume that the SingleMarket led to a reduction in trade costs, amounting to a tariff equivalentof 2.5 per cent. In the calculation ofPROTi, tcij is added to the tarifftijapplicable to each trade flow, and set to zero as of 1993 for trade flowsbetween the EU-12 countries. The European Economic Area (see Table 1),which is relevant here for the relations between AT, FI, SE and the EU-12, isassumed to have halvedtcin 1994. In 1995, after the EU accession of thesethree countries, the remaining half oftcis assumed to have been eliminated.Of course, the choice of a 2.5 per cent tariff equivalent of the Single Marketis somewhat arbitrary, but the same argument can be held against ignoringthe Single Market (i.e. setting the effected reduction in trade costs to zero).

In order to obtain our final index of integration INTi,t, we scale thereductions in PROTi,t with its initial value in 1950, giving the variableINTi,tthe interpretation of the percentage of the total post-war integrationachieved by countryiat timet:

INTi,t=PROTi,1950 PROTi,t

PROTi,1950. (5)

Beside its easier interpretation, this scaling has further advantages. First,it mitigates the uncertainty with respect to the initial tariff levels in the1950s, compared with the relatively good information on the timing andrelative size of the tariff reductions. Furthermore, the construction ofINTi,tas index, which can vary between zero (initial degree of integration) and one(full integration), links the variable more closely to the theoretical modelsby Romer (1990) or Young (1998). Of course, these advantages come at thecost of ignoring differences in the absolute progress in integration: Initiallymore protectionist countries had a longer way to go and maybe also more to

gain. This point, however, may be addressed by testing for country-specificcoefficients ofINTiin our panel estimation. Figure 2 shows the development


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Table 2: Description of the Variables Used in the Estimation

Variable Description Units Sources

lnyi,t Average growth rate of GDP per worker(Y/L). Y= real GDP in US$ (1990prices, 1990 PPPs),L = employment innumber of persons.

% p.a. OECD: National Accounts,Economic Outlook; Maddi-son (1992).

ln ki,t Average growth rate of capital perworker (K/L). K= real capital stockin US $ (1990 prices, 1990 PPPs),

calculated using a perpetual inventorymethod: Kt= Kt1(1 )+ It, withIt= gross fixed capital formation, =depreciation rate (assumption: 5%).Initial level: K1955 = IHP55/(gI,50-60),where IHP55 = HodrickPrescott fil-tered level of investment in 1955,

gI,50-60 = average growth rate p.a. ofinvestment from 50 to 60 (de la Fuenteand Domnech 2000).

% p.a. OECD:National Accounts.

INTi,t (Absolute) change in level of integra-

tion = (INTi,t) (INTi,t1), whereINTi,t= average level of integrationin periodt.

% p.a. IMF: IFS; DoT; El-Agraa

(2001); Breuss (1983); owncalculations; see Section 3.

ln hi,t Various measures of human capital(mean years of schooling, attainmentrates).

years%

Barro and Lee (2000); dela Fuente and Domenech(2000).

i,t Average growth rate of GDP deflator. % p.a. OECD: National Accounts;IMF: IFS; Maddison(1992).

OPENi,t Openness: (real) imports plus exportsin per cent of GDP. % OECD:National Accounts.

Note: i = 1,...,14,t= 1,...,10 (5-year intervals, 19502000). There are some missing obser-vations for the period 19501960 which had to be approximated by inter/extrapolation.

to missing data, 14 countries remain. To smooth out cyclical fluctuations

and distortions by short-run shocks, we use overlapping, five-year averages(t= 110: 19501955, 19551960, ..., 19952000) and calculate the average


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since both the initial and the level at the end of the period may be consid-

erably off the trend path of output (Temple 1999: 119). As output measurewe use real GDP data (in 1990 prices, 1990 PPPs) from the OECD ratherthan Penn World Tables (PWT) data; thus the calculated growth rates areequal to the real growth rates in national currencies.4

5 Estimation Results

Table 3 reports the estimation results for the empirical models outlined

above. To control for the substantial slowdown of growth since the early1970s, which followed the golden age of high economic growth in Europefrom 1950 to 1970 (Maddison 1995), we include a level dummy (D70-00),taking a value of zero for the periods 14 (19501970) and a value of1 for the periods 510 (19702000). At the bottom of Table 3, we alsoreport F-Tests for the null of parameter homogeneity across countries.Since the hypothesis of a common parameter is rejected for the interceptandD70-00 in de facto all models, we use a fixed effects specification with

variable intercept and allow the coefficient ofD70-00

to vary across countries.In Table 3, however, only averages of the country-specific intercepts andcoefficients ofD70-00 are reported. The first two columns show the leastsquare dummy variable (LSDV) estimates of our empirical models (2) and(3), controlling for the slowdown of growth in the 1970s byD70-00. The levelof integration (INT), corresponding to the hypothesis of permanent growtheffects, is insignificant and also shows the wrong (negative) sign (column(a)); even if we allow for heterogeneous coefficients (as might be suggestedby the F-statistic, whose p-value is only slightly above the 10 per cent level),only 5 coefficients turn out significant, 3 of which with the wrong sign.These results can be enforced by unit root tests on yearly time series of thevariables, a testing strategy suggested by Jones (1995): While AugmentedDickeyFuller tests indicate that lnyi,tis stationary for all countries, the

4 Nuxoll (1994) shows that growth rates calculated from data measured at internationalprices (like the PWT) may be systematically distorted by the so-called Gerschenkron ef-fect. Although the PWT do not exhibit a serious bias due to the high level of aggregation,their growth rates differ from the national accounts data growth rates. Consequently, Nux-

oll (1994: 1434) argues that using domestic prices to measure growth rates is more reli-able, because those price characterize the trade-offs faced by the decision-making agents,and hence have a better foundation in the theory of index numbers Probably the ideal


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Table 3: Panel Estimates for EU Member States, 19502000

Dependent variable: lnyi,t

(a) (b) (c) (d) (e) (f) (g) (h)

Intercepta 4.186 3.791 4.967 4.303 4.119 2.172 2.438 2.053

D70-00 a 1.101 2.178 2.146 2.570 2.579 0.903 1.258 1.003

INTi,t 0.277 0.284 0.220 0.306 0.139 0.104

(5.84) (4.39) (3.85) (2.09) (2.58) (2.49)

INTi,t 0.059 ( 1.43)

ln ki,t 0.346 0.271 0.346 (6.88) (4.63) imposedb

lnyi,t1 0.008 ( 0.01)

OPENi,t 0.024 ( 0.54)

i,t 0.010 ( 0.19)

F-tests for parameter homogeneity

Intercept 2.07 1.98 1.18 2.95 1.34 1.38 1.66

D70-00 1.89 2.48 1.88 2.87 1.72 1.93 1.72

INTi,t 0.76 0.77 1.16 0.77 0.69

ln ki,t 1.25 1.72

INTi,t 1.56 1.25 1.72 0.79

Regression statistics

SEE 1.177 1.079 1.094 0.931 0.984 1.024 1.006 1.009

R2 0.562 0.631 0.641 0.710 0.679 0.668 0.682 0.406

Adj. R2 0.451 0.538 0.522 0.593 0.549 0.584 0.599 0.256

Period 19502000 19552000 19652000 19502000T= 110 T= 210 T= 410 T= 110

, , indicate significance at the 10, 5 and 1 per cent level respectively.Note: t-values in parentheses (calculated using White heteroscedasticity-consistent standarderrors). All models except (e) estimated using the LSDV approach. Model (e): first-differences GMM estimation of (b), using lagged differences as instruments for INTit,starting with lag two (INTi,t2). GMM estimation was carried out using DPD98 by Arel-lano and Bond (1998).a Reported numbers are averages of country-specific coefficients. b Coefficients imposed

according to the average income shares of capital (19871989) reported by Coe and Help-man (1995) (primary source: OECD, Analytical Database), AT: 0.358, BE: 0.355, DE: 0.401,DK: 0 338 ES: 0 391 FI: 0 331 FR: 0 354 GR: 0 29 IE: 0 281 IT: 0 376 NL: 0 390


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null of a unit root cannot be rejected for any of the indicesINTi. Thus, there

cannot be a long-run equilibrium relationship between the two variables,at least not in the linear form as postulated by (3).

On the contrary, the change in the variableINT, corresponding to thehypothesisof levels effects of integration, enters significantly at the 1 per centlevel (column (b)).5 Interestingly, the restriction of a common coefficientfor INTi across countries cannot be rejected; given the construction ofINTas an index, whose absolute change from 1950 to 2000 varies onlyslightly across countries (see Section 3), the gains from integration (in percent of their own GDP) seem to have been shared symmetrically amongthe EU member states. The same results are obtained in tests of parameterhomogeneity between groups of large and small countries. The coefficientofINTis not only statistically but also economically significant: as willbe outlined more in detail below, the implied level effect on the EUs GDPper capita amounts to some 26 per cent. Finally, note that the numbersreported for the fixed effects andD70-00 show a plausible dimension: Onaverage, annual growth was lower by some 2 per cent in the period since1970, a value similar to that reported by Maddison (1995: 64, 79).

Of course, this result requires some sensitivity analysis. The most criticalfeature is that the inclusion of a full set of time dummies renders INTinsignificant. This is not really surprising: The synchronization of many lib-eralization steps leads to a very high partial correlation between the variableINTand the time dummies (a regression ofINTon 8 time dummies(andD70-00) yields anR2 of 0.77). On the other hand, the time dummies,capturing a large part of the variation ofINT, may also be interpreted toreflect integration effects; of the five time dummies that enter significantly,all but one (for the period 19551960) take a positive value and their (net)level effect is comparable to that implied by the coefficient ofINT. Againstthis background and since time-specific institutional changes have also beendriven by European integration to some extent, we do not regard it as plau-sible to interpret the effect ofINTas spurious; but of course, we cannot besure that the dummies do not actually capture omitted variables unrelatedto integration. Thus a skeptic might still argue that the time dummies re-flect the positive effect of institutional and structural factors that vary overtime but not across countries, and that integration had no effect. Hence the

variable INTis in some way also vulnerable to Rodriguez and Rodriks


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(2001) well-known critique (though their primary concern relates to the

cross-country variation in institutional characteristics that may be mistak-enly captured by trade variables). Even with an improved measurement ofintegration, collinearity problems will continue, to some extent inevitably,to aggravate the firm and unambiguous empirical establishment of the linkbetween integration and growth.

We carry on with our preferred model in column (b) in order to seewhether our results are also sensitive to other robustness checks. We firstcheck the sensitivity with respect to changes in the estimation period, re-estimating the model without factor accumulation (column (b)) for allpossible sub-periods including at least 6 observations (30 years), which

yields us 13 models. The coefficient ofINTvaries between 0.19 and 0.32but always remains significant at the 1 per cent level (see Table A1 in theAppendix for the detailed results). We also ran the regression for the sub-periods 14 and 510 withoutD70-00. Again the significance level ofINTis unchanged, but its coefficients for the periods 14 appear to be higherthan for the periods 510. The significance of this difference can be testedin a regression for the total period (110) by including an interaction term

ofINTandD70-00 . Its coefficient is negative as expected and significant atthe 10 per cent level (p-value: 0.055); the implied parameters forINT50-70and INT70-00amount to 0.43 and 0.21 respectively. In the light of the weaksignificance of the interaction term, however, we continue with one coeffi-cient for the whole time period, but add that the size of the implied growtheffects over the total period hardly differs between the two specifications.

As shown by Levine and Renelt (1992), it is also important to check therobustness of the results against the inclusion of further variables. We addthree control variables: First, one could object that INTsimply measurescatching-up in the course of post-war reconstruction. Against this can beheld that by 1950 recovery from war was complete and Europes economieswere back on their pre-war growth paths (Maddison 1995: 71). Nevertheless,we check the robustness of the results against including the initial levelof output per worker (yi,t1). Second, we include the rate of inflation (proxied by the relative change in the GDP deflator), since Henrekson etal. (1997) find in their cross-section growth regression that the dummy forEC/EFTA membership becomes insignificant, when inflation is controlled

for. Third, we include the change in the share of trade in GDP (OPEN), orits level(OPEN), as general indicator for openness. Column (c) in Table 3


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variables is used or if the variables areadded separately. The control variables

are never significant and the coefficient of the variable INT is hardlyaffected. The same holds true if the level ofOPENis included instead of itschange. Repeating this robustness analysis for different estimation periods(see Table A1 in the Appendix for details) we obtained the following results:Including inflation or openness never affects the significance ofINT.Including the initial level changes the significance ofINTin 6 of the 15models: In 4 cases it remains significant at the 10 per cent level; only in 2cases is it rendered insignificant. This is probably due to the aforementionedfact that the coefficient ofINTis smaller for the period 19702000, sinceall cases in which INTis fragile focus on this later period. Running theregression over the whole period 110 and controlling for the lower effectofINT since 1970 by an interaction term between INT and D70-00,however, INT(and the interaction term) remains significant at the 1 percent level, whatever combination of the control variables is included. Afterall, we may carefully conclude that economic integration has had a leveleffect on the EU-15s post-war growth path, which appears to be have beenmore pronounced in the period from 1950 to 1970.6

A further concern often raised in the context of growth regression isthe potential endogeneity of the right-hand side variables; also for eco-nomic policy measures such as integration one could argue that causalitymay run in the reverse direction: It may be politically easier to liberalizein periods of high growth, while in times of poor performance it may betempting to introduce protectionist measures. To check the sensitivity ofthe results, we employ a first-differences GMM estimator for the modelin column (b). As instruments for the variable INTin second differences(INT

it), all available lags of its first difference datedt 2 and earlier

are used (INTi,ts, s 2). Though originally introduced in the contextof dynamic panels (Arellano and Bond 1991), the extension of this GMMframework to problems like measurement error and endogeneity of theright-hand side variables is straightforward (Bond et al. 2001). Unfortu-nately, this approach implies a loss of three observations, which is particu-larly hurtful in our case, since we have to exclude the period of the customsunion. To ensure comparability, Table 3 shows the results of both the LSDV(column (d)) and GMM estimation (column (e)) for this shorter period

6 It is well known that the LSDV estimator is biased in dynamic panels (see Nickell 1981).Th l i f d i d l (i l di ) d t h h h


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from 1965 to 2000. INTi remains highly significant; its coefficient even

increases compared with the LSDV estimate. This result, however, has tobe qualified in the light of the ambiguous results concerning the validity ofinstruments: A Sargan test of overidentifying restrictions cannot reject thenull of valid instruments (p-value: 0.58). In contrast, the null of the absenceof second-order serial correlation, a requirement for instrument validity, isrejected at the 10 per cent level (see Arellano and Bond (1991), for details onthe instruments tests). A possible interpretation of the insignificant Sargantest in the presence of second-order serial correlation is that INTi,tmightin fact be only predetermined, ruling out contemporaneous correlation be-tween INTi,tand the error term i,t (i.e. E(INTi,ti,s) = 0, alli, s


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Coe and Helpman (1995). The results for these restricted estimates, which

actually correspond to a direct test of the empirical model (1a), are shownin column (h). The coefficient ofINTis still highly significant, thoughsomewhat lower than the unrestricted estimate. Comparing the coefficientofINTin columns (g) and (h) with that of the model without factor accu-mulation (column (b)), we may carefully conclude that both investment-ledand technology-led growth played a significant role, with investment-ledgrowth accounting for some 5063 per cent of the total effect. Here, therelative contribution of investment-led growth was calculated as residual bydeducting the estimated technology-led growth effect from the total effectimplied by the results in column (b). Of course, this issue can also be tackledfrom the other side, i.e. by calculating the technology-led growth effect asresidual, deducting the estimated investment-led growth effects from thetotal effect. The investment-led growth effects are obtained by directly esti-mating model (1b), i.e. regressing the growth of the capital stock on INT(Table A2), and then translating this effect on the capital stock into outputeffects using either the estimated coefficients of ln kfrom column (g) orthe corresponding capital shares (see note of Table 3). Since none of these

approaches can a priori be said to be superior we provide a range of estimatesof the possible distribution between technology and investment-led growtheffects in the simulation below. Before proceeding with the simulation itis worth noting that in none of the models in Table 3, the hypothesis ofa homogenous parameter for INTfor all countries can be rejected; thesame holds true for the direct estimates of the investment-led growth effects(Table A2); i.e. neither technology nor investment-led growth effects havefallen disproportionately on particular member states, or on small or largecountries.

We go on to use our preferred specifications to simulate the level effectsof integration. The preferred model without factor accumulation (Table 3,column (b)) is used to simulate the overall effect. The results are given inTable 4, which shows both the actual level of GDP per capita in 2000 aswell as its hypothetical level if no integration had taken place since 1950(i.e. INTi,t= 0, all i, t). As can be seen from column (d), integrationhas induced sizeable level effects, amounting to some 26 per cent for theaggregate EU (or some 20 per cent in terms of actual values (b)); country-

specific values deviate only slightly, indicating that there have been noobvious asymmetries in the gains from integration. As outlined above,


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technology-led or investment-led growth effects can be estimated, with the

contribution of the other channel being calculated as residuals. Second, ineach case the estimated or the calibrated parameters of ln kcan be used.Column (e) shows the minimum and maximum outcome for the shareof investment-led growth effects in the total effect for each country. Theoverall results indicate that both integration-induced increases in efficiencyas well as induced investments played a significant role in promoting theEU-15s post-war growth. Accounting for one-half to three-quarters of theoverall effect, investment-led growth effects seem to have been slightly moreimportant.

Table 4: Growth Effects of Economic Integration for EU Member States, 19502000

GDP per GDP per GDP per Total level Investment-led effectworker 2000 capita 2000 capita 2000 effect as as % of total effect

actual no integration % of (c) from to

(a) (b) (c) (d) (e)

AT 40,288 20,078 15,716 27.8 53.0 72.0BE 50,815 19,715 15,806 24.7 52.7 71.9DE 47,732 20,417 16,255 25.6 52.8 80.3DK 41,857 21,403 17,482 22.4 52.5 67.6ES 40,483 14,653 11,436 28.1 53.1 79.7FI 43,013 19,363 15,517 24.8 52.7 67.5FR 49,629 19,885 15,682 26.8 52.9 71.2GR 29,484 10,958 8,570 27.9 53.0 58.7IE 50,307 22,411 17,802 25.9 52.9 57.3IT 50,969 18,460 14,537 27.0 52.9 76.8NL 45,509 19,974 16,103 24.0 52.6 78.8PT 25,137 12,184 9,456 28.9 53.1 66.9SE 41,481 19,429 15,971 21.6 52.4 67.4UK 39,849 18,707 14,907 25.5 52.8 62.8

EU 44,577 18,549 14,709 26.1 52.9 73.2

Note:(a), (b), and (c) in US$at 1990 prices, 1990 PPP. Per capita values calculated by mul-tiplying the simulated values (per worker) with the employment/population ratio.

It is reassuring that our results are not far off those from other studieson the relationship between trade (openness) and growth. In particular,


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bership dummies) on the growth rate in a range from 0.6 to 1.3 per cent p.a.

(which the authors favour to interpret as permanent effect on the growthrate). With a level effect of some 26 per cent over 50 years, the effect onthe average growth rate implied by our results amounts to some 0.5 percent, which is in line with the Henrekson et al. study. In contrast to theirinterpretation as a permanent effect, however, our results suggest that theeffects of integration are only of temporary nature.

Our results are also compatible with the closely related literature ontrade and growth. Greenaway et al. (1998), in a panel approach with 73countries (mainly developing countries), obtain a level effect of openness(measured with the SachsWarner index) of some 46 per cent; regardedas long-run difference in GDP per capita between more open and moreclosed economies they regard this as a reasonable number. The compre-hensive survey of studies on the relationship between trade and growthby Lewer and Van den Berg (2003) finds surprisingly consistent results:a 1 percentage point increase in export growth is associated with a one-fifthpercentage point increase in economic growth. Against the background ofthe rapid growth of the EU-15s trade since 1960 (some 6 per cent p.a.)

and the significant contribution of European integration to the growthof trade (Badinger and Breuss 2004), our estimates are of a comparabledimension.

Our results concerning the role of investment-led and technology-ledeffects are broadly consistent with the few previous studies that attempt todistinguish between the effects of trade on factor accumulation and technol-ogy. In Frankel and Romer (1999), two-thirds of the growth effect (of trade)materialize over technology, one-third over (physical and human) capi-tal accumulation. Wacziarg (2001), using a simultaneous equation model,finds that 63 per cent of the overall effect are investment-led, 22.5 per centtechnology-led (the rest is mainly due to stabilizing economic policy). Ourresults reinforce the view that both induced capital accumulation and in-duced technological advances are important channels via which growtheffects of economic integration materialize.

As final important point, our results have to be interpreted in a broaderinternational setting. In comparing the EUs post-war growth performancewith that of other countries, it is important to bear in mind that our integra-

tion variable reflects European integrationandGATT liberalization. ThusEuropean integration itself, strictly speaking, only accounts for integration


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substantial economic integration. Nevertheless, progress in integration was

certainly more pronounced for the EU countries than for the United States.If integration generated level effects as suggested by the estimates, the EUshould have caught up in terms of real GDP per worker against the UnitedStates. This has indeed been the case: In 1950 the EUs GDP per worker wassome 40 per cent that of the United States; in 2000 it amounted to some80 per cent (see Maddison (1995) for a more detailed discussion of thiscatching-up process). Since the European economies were back on theirpre-war growth path by 1950 (Maddison 1995: 71) this catching-up can-not be purely attributed to reconstruction and it may be argued that theEU countries would have kept farther behind the United States withoutEuropean integration.

Thequestion whether thepost-warevolution of living standards betweentheEU and non-EU membersis significantly related to European integrationmay also be judged more rigorously by regressing the EUs GDP per workerrelative to that of some control countryj(yEU,t/yj,t;j= the United States,Australia, New Zealand, Japan, Canada, Norway, Switzerland, and Iceland)on the (lagged) level of the EU-15s integration(INTEU,t1):

8

yEU,tyj,t

= + yEU,t1

yj,t1+ s

EU,t

sj,t+ u

EU,t

uj,t+ INTEU,t1 + t.

(6)

The lagged dependent variable is included to allow for a more generaldynamic structure of the model; two further variables are included: therelative investment ratio,sEU,t/sj,t, to control for neo-classical catching-up,and the relative unemployment rate,uEU,t/uj,t(taken from the AMECOdatabase), since typical increases in EU unemployment tended to makeGDP per worker grow even without real GDP growth.

Table 5 reports the estimation results of (6) for the time period 19602000, using several control countries. Where therelative unemployment rateor the relative investment ratio turned out insignificant, they were excludedfrom the final regression (the values reported for the other variables andthe regression statistics are that of the final model). For all control countries

8 The integration measure for the EU is calculated as weighted average of the country

values (see Section 3) and divided by 100 (to obtain a more comfortable coefficient),where the respective countries shares in the EUs total trade (again imports and exports)are used as weights The lagged value is chosen because it yields a (slightly) better fit This


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Table 5: Estimation Results for Catching-Up Specification (6), 19602000

Dependent variable:yEU,t/yj,t

US CA AU NZ JP CH NO IS

Intercept 0.001 0.078 0.144 0.201 0.118 0.031 0.196 0.564

(0.04) (3.33) (1.37) (2.681) ( . 94) (2.16) (2.45) (3.94)yEU,t1/yj,t1 0.898

0.897 0.531 0.747 0.851 0.967 0.857 0.417

(23.58) (22.25) (5.29) (6.99) (9.69) (43.99) (12.50) (3.23)sEU,t/sj,t 0.044

0.009 0.177 0.034 0.308 0.092 0.050 0.094

(2.63) ( . 33) (2.62) (0.99) (1.74) ( 1 .37) ( 2 .24) (2.72)uEU,t/uj,t 0.003 0.006 0.056

0.001 0.002 0.001 0.007 0 .003

( 0 .44) (0.25) (3.06) (0.79) (0.32) ( 1 .26) (1.48) ( 2 .82)INTEU,t1 0.047

0.033 0.159 0.158 0.098 0.019 0.016 0.090

(2.54) (1.72) (4.33) (2.04) (1.75) (1.89) ( 1 .60) (3.26)

Implied leveleffect (%)a 43.1 23.9 23.0 38.2 46.3 (0) 10.7

Regression statistics

LM-SCb 2.85 9.31 5.42 7.64 0.989 11.46 3.89 6.82SEE 0.008 0.010 0.018 0.028 0.022 0.012 0.017 0.028Adj. R2 0.996 0.994 0.931 0.979 0.989 0.995 0.849 0.880

, , indicate significance at the 10, 5 and 1 per cent level respectively.Note: t-values in parentheses, calculated using White heteroscedasticity-consistent standard errors. Estimation period for AU is 19642000 for reasons of data availability.a Calculated as difference between actual relative GDP per worker in 2002 and the hypothetical valuewithout integration((yEU,2000 y

noINTEU,2000)/yj,2000), divided by the actual relative GDP per worker in

2000. The hypothetical scenario without integration (ynoINTEU,2000/yj,2000) is obtained from a dynamicsimulation of the estimated equation (6), assuming that the level of integration remained at that ofthe first observation (residuals were included to reproduce the actual values in the baseline scenario). b LM test of Breusch (1978) and Godfrey (1978) for serial correlation, assuming a maximum orderof five; chi-square distributed with five degrees of freedom (choosing a lower order from one to fourproduces no further significant results). For CA and CH where the residuals exhibit serial correlation

NeweyWest standard errors were used (explicit adjustment for autocorrelationthe more appropri-ate answer to serial correlation in the presence of a lagged dependent variabledoes not change theresults for the integration variable, suggesting that the degree of inconsistency is negligible).

except Norway the integration variable enters significantly at least at the10 per cent level.9 This suggests that the EU-15s integration has supportedthe EUs catching-up process, or to put it differently: Without integration

9 In three cases the results are sensitive to including the insignificant investment ratio and


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the EU would have kept (farther) behind the living standards of other

OECD countries.10 The level effects implied by the estimates are reportedin the lower part of Table 5 and range from 10.7 (0 for Norway) to 46.3per cent, compared with the level effect of 20 per cent obtained in ourpanel estimates (Table 4). Note that in the regressions with the largestlevel effects implied, the standard errors of the coefficients ofINTEU arefairly large, such that the 20 per cent result is conveniently contained instandard confidence intervals. There is no convincing explanation for theinsignificant result for Norway: The fact that it underwent a very similarintegration scheme as the EU members is also true for Switzerland andIceland where a significant result is obtained; it may be due to the littlevariation in the dependent variable, since the living standards of the EUand Norway evolved very similar, implying an almost constant dependentvariable.

One could argue that it would be a better approach to replace thevariableINTEU(which measures the relative progress in the EU-15s in-tegration, see Section 3) by the ratio of the absolute level of integrationof the EU to that of the control country. This is ruled out for reasons

of data availability, however; after all, the reduction of our sample to theEU-15 is the cost of using an improved integration measure. Against thisbackground, (6) is a feasible compromise which allows us to judge the re-sults for the EU sample in a broader international setting and provides uswith an additional robustness check. The particular values of the coeffi-cients, however, should not be overstressed. Overall the significant resultsfor the integration variable buttress the conclusions obtained so far; atthe same time the suggested contribution of the EU-15s integration toits catching-up process in the post-war period adds another qualification:The results may be specifically within-EU effects and cannot easily begeneralized.

6 Conclusions

This paper provides support for the hypothesis that European integrationhas significantly contributed to the post-war growth performance of the

10 Of course, assuming that the EU-15s integration had not taken place ceteris paribus issomewhat artificial particularly in comparison with the other European countries (CH IS


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current EU member states. Although the results imply that growth effects

have only been of temporary nature, the suggested level effects are sizeable:GDP per capita of the EU would be approximately one-fifth lower todayif no integration had taken place since 1950. An important qualification isthat the results are not completely robust to controlling for time-specificeffects which are highly correlated with our integration variable due to thesynchronization of many integration steps. Additional research is neededto establish more firmly the link between integration and growth, despiteincreasing and surprisingly consistent evidence: Until we agree on a logicalexplanation why trade [integration] and growth go together, it is not likelythat we will agree that the statistical results have settled the matter (Lewerand Van den Berg 2003: 391).

The size of the level effects suggested by our estimates supports Templesargument that undervaluing level effects is fundamentally misguided. ... Itshould not worry us that long-run growth ... is unresponsive to policy;instead level effects ... should be central to policy analysis (Temple 2003:509). In contrast to previous studies, we find that the ties between integra-tion and growth run both over increases in efficiency as well as induced

investments. Accounting for one-half to three-quarters of the total effect,however, investment-led growth seems to have been slightly more import-ant. A further noteworthy result is that the hypothesis of symmetric gainsfrom integration cannot be rejected, i.e. no obvious small- or large-countrybonus appears to exist.

Our estimates also suggest that the EUs post-war catching-up processvis--vis the United States and other countries was supported significantlyby the process of European integration. Hence, the results obtained heremay be specifically within-EU effects and cannot easily be generalized,e.g. to countries that have moved very close to the technology frontier (suchas many EU member states today). Taken together with the rejection ofpermanent growth effects this has an important policy implication: Thegrowth stimulating effect of integration, achieved so far, holds no promisefor the EUs future performance. To achieve the ambitious goal set out bythe European Council in the Lisbon Strategy in 2000 (becoming the mostcompetitiveanddynamic knowledge-basedeconomy), or tokeep at least upwith the United States in the twenty-first century, substantial challenges

such as making the Single Market more dynamic, boosting investmentinto knowledge and improving the macroeconomic policy framework of


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Appendix

Table A1: Robustness Analysis

Without9 Obs. 8 Obs. 7 Obs. 6 Obs. D70-00

1-9 2-10 1-8 2-9 3-10 1-7 2-8 3-9 4-10 1-6 2-7 3-8 4-9 1-4 4-1050-95 60-00 50-90 55-95 60-00 50-85 55-90 60-95 65-00 50-80 55-85 60-90 65-95 50-70 70-00

INTi,ta 0.278 0.273 0.274 0.274 0.210 0.307 0.268 0.207 0.220 0.319 0.305 0.190 0.217 0.426 0.256

Control variablesb

lnyi,t1 rob rob rob rob 10% rob rob 10% frag rob rob 10% 1 0% rob fragi,t rob rob rob rob rob rob rob rob rob rob rob rob rob rob rob

OPENi,t rob rob rob rob rob rob rob rob rob rob rob rob rob rob rob

a Coefficient ofINTi,t(no control variables added); significant at the 1 per cent level in all cases. b Results forrespective period, when control variables are added: rob ... robust, i.e. remains significant at the 1 per cent levelafter including the respective variable; frag ... fragile, i.e. rendered insignificant by the inclusion of the respectivevariable.

Table A2: Estimates of Investment-Led Growth Effects for EU Member States,19502000

Dependent variable: ln

ki,t (a) (b)

Intercept 5.006 23.509D70-00 3.399 1.227INTi,t 0.510

0.472

(6.90) (7.67)ln ki,t1 1.830

( 4.48)

F-tests for parameter homogeneity

Intercept 2.60

1.74

D70-00 1.65 1.00INTi,t 0.23 0.21

Regression statisticsSEE 1.482 1.373R2 0.673 0.722Adj. R2 0.590 0.649Period 19502000(T= 1, ...,10)

See note of Table 3. Column (b): check for robustness against including the initial level of

capital per worker.


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Baldinger 2005 Growth Effects of Economic Integration