Effects of European integration on Austria’s economy

Abstract

High expectations were placed on the project of European economic integration and Austria’s participation in it. Economists had expected that the Single Market would provide a positive supply shock, i.e. rising productivity, resulting in more growth. The optimistic forecasts for neither the EU nor for Austria were borne out by actual economic trends. Economic growth as well as productivity growth decelerated, while unemployment increased. Monetary union was implemented with an economic policy framework, the Stability and Growth Pact (SGP) that geared monetary policy only to price stability and at the same time prescribed restrictive fiscal policies. The SGP therefore reveals a deflationary bias. The existing literature on the effects of EU accession on the Austrian economy by design fails to account for the restrictive effects of the SGP. The paper presents simulation results allowing for supply shocks as well as demand shocks. The simulations are based on a medium‐sized macroeconometric model. The results indicate that recent studies overestimate the positive effects of European integration. A simulation of the restrictive demand‐side effects of the SGP, with the assumption that around half of the fall in public consumption growth in the Euro countries can be attributed to the SGP, produced significant negative growth effects. The net effect suggests a negative quarter percentage point p.a. during the period 1995–2004.

Keywords:

• European integration
• Austria
• macroeconomics
• Stability and Growth Pact

JEL classifications:

• E100
• E170
• E620
• F150

Acknowledgement

This article is based in part on a study commissioned by the Chamber of Labour, Vienna. The author would like to thank Stefan Ederer for his outstanding work as research assistant. The author would also like to thank Fritz Breuss, Markus Marterbauer, Ewald Nowotny, Werner Raza, Sepp Zuckerstätter, Malcolm Sawyer and an anonymous referee for comments. An earlier version of the paper was presented at the conference ‘Macroeconomics and Macroeconomic Policies – Alternatives to the Orthodoxy’, Berlin, October 2005. All remaining mistakes are those of the author.

Notes

1. This sounds easier than it is. As an inflationary economic policy can scarcely be realized under the SGP, this means that in the countries with higher inflation (or lower productivity growth), the adjustment has to be made via deflationary trends, not least nominal wage reductions.

2. For a more mainstream criticism see Eichengreen and Wyplosz (1998).

3. The exact demarcation is of course somewhat arbitrary: preparations for the Single Market, whose timetable had already been known since 1986, take place in the first ‘less integrated period’, while the Single Market itself and the preparation for, as well as the implementation of monetary union fall within the second period. However, the chosen periods are long enough to smooth out business cycles. A change in the exact demarcation would not alter the results qualitatively.

4. Data taken from the Eurostat AMECO database.

5. In the 1970s, Austria pursued an extremely successful economic policy, often called Austro‐Keynesianism, which enabled it to keep unemployment significantly below the European average. Today such a policy would no longer be possible. For instance, EU competition policy would not allow subsidizing nationalized industries to stabilize employment. However, privatization often occurred prior to EU accession.

6. It is possible that labour productivity has been underestimated in recent years owing to flexibilization on the labour market, e.g. increase in part‐time work.

7. The greater the difference between interest rates and (nominal) economic growth, the more restrictive the monetary policy.

8. This finding is also affirmed by Badinger and Breuss (2005), who estimate the mark up and marginal costs for 46 Austrian industries and find no evidence of a general reduction in the mark up.

9. Given that measured, effective productivity depends on capacity utilization, it is also possible that while technical productivity has increased, measured productivity is flat due to the low rate of capacity utilization because of a lack of demand.

10. Breuss (1997) also presents a separate estimate of the effects of the 1996 budget cuts, although he denies a causal link between the budget cuts and the convergence criteria.

11. Two other deviations from the Wifo macro model are driven by pragmatic reasons. The model does not use a nominal wage function as this showed strong evidence for statistical breaks. A real wage function is used instead comprising a term for non‐anticipated inflation change (i.e. the difference in the inflation rate). A productivity function was used instead of an employment function as this makes it easier to simulate productivity shocks.

12. Public investment will have supply‐side effects very different from those of public consumption expenditures. However since this study focuses on the demand‐side effects of public expenditures, this difference is ignored.

13. The estimating equation yielded the following result: DLOG(PIMP) = −0.01 + 0.72∗INFL_EU12. The coefficient is statistically significant at the 1% level; R2=0.45, DW=2.04.

14. These overall effects should not be strictly interpreted in the sense of Austria not acceding to the EU, but rather as effects of the specific form of European integration in which Austria has participated on the Austrian economy.