Introduction and overview

European economies are fast approaching complete integration, with elimination of legal restrictions to trade and factor mobility, increasing credibility of fixed exchange rates, and better coordination of economic policies. The legal and institutional process of economic integration among the ‘core’ countries of the European Community (EC) will be essentially complete by the end of 1992. As linguistic and cultural barriers to economic interaction weaken as well, Europe should soon become as much of a single economic entity as the United States of America. The question naturally arises of what difference this will make to overall economic performance on the one hand, and to regional developments on the other.

If economic borders represented artificial restrictions in an otherwise undistorted economic system, their elimination would necessarily yield welfare improvements at the aggregate level. An integrated Europe should then enjoy increased production efficiency and faster capital accumulation. Baldwin (1989) and Rivera-Batiz and Romer (1991) studied the effects of economic integration in models of investment-driven economic growth. Increasing returns to scale are crucial to the mechanics of growth in models which account for use in production of non-accumulated factors (such as land and labour). Since constant returns to accumulation of knowledge and/or physical capital are necessary for investment to sustain steady growth, aggregate production must have increasing returns to scale as a function of accumulated and non-accumulated factors together.